Select Committee on Environmental Audit Second Report


81. As the CCL taxes energy consumers rather than suppliers, it is not primarily designed to encourage energy generation to be less carbon-intensive. However, one element of the CCL package is aimed at assisting this goal: organisations are exempted from paying the Levy on electricity generated from renewable sources, and on electricity generated by combined heat and power (CHP).[112] In the case of CHP, the input fuel used to generate the heat and power is also exempt from the Levy.[113] These Levy exemptions form part of the Government's respective strategies for delivering two key targets in the UK Climate Change Programme: generating 10% of the UK's energy supply from eligible sources of renewable energy, and increasing UK CHP capacity to 10 gigawatts (GW), both by 2010. Most recent published statistics show that, in 2006, the proportion of the UK's electricity generated from renewables stood at 4.6%,[114] while CHP capacity was nearly at 6 GW.[115]

82. The effect of the Levy exemptions on renewables and CHP capacity is indirect. To access the exemption, business customers sign contracts similar to the kind of 'green tariffs' offered by electricity suppliers to households. The Levy exemptions offer a financial incentive to businesses to select such contracts; if enough demand is created, this should in theory provide generators with an extra incentive to invest in more capacity, so that they can sell more contracts. In other words, the Levy exemptions are designed to increase market 'pull' for new capacity, to complement the 'push' that comes from other measures (chiefly, in the case of renewables capacity, the Renewables Obligation) which by regulation mandate generators to increase capacity, and through subsidy or trading mechanisms directly incentivise them to do so. Ofgem issues suppliers with a Levy Exemption Certificate (LEC) for each megawatt hour of qualifying electricity generated for consumption within the UK, with suppliers surrendering these LECs to their business customers. This is meant to ensure that suppliers cannot sell more electricity designated as being generated from renewables or CHP than they actually produce from these sources.

The exemption on green electricity has increased demand but not supply

83. In looking at the effectiveness of the exemption on electricity from renewables, it is important to differentiate between its effects on the market for 'green tariff' contracts, and the effects that this in turn has on the construction of new windfarms, biogas plants, solar installations, etc.

84. The evidence we received suggested that demand for 'green tariff' contracts among business customers had increased markedly in recent years. The memo from E.ON was clear that the Levy exemption had played a decisive role in this: "our experience in the business to business retail market indicates a positive impact on renewable products."[116] EDF Energy agreed—but at the same time stressed another factor in this rise in demand: "There is a strong and growing demand for levy exempted certificates (LEC) due to the financial benefits of the exemption and the corporate driver to be a responsible organisation."[117] Regarding this latter point, it is difficult to isolate the impact of the Levy exemption from the wider influence of rising business interest in acting on principles of corporate social responsibility (CSR). But it is interesting in this context to note the stress placed on CSR motives in the following guidance for business customers from the Carbon Trust:

    For the majority of companies, improving energy efficiency will be the most effective way to reduce the levy they pay.

    It is then worth considering purchasing CCL-exempt energy from renewable sources, often referred to as 'green energy'.

    Renewable sources may not be cheaper, as price premiums may offset levy reductions, but they are still good for your company's reputation and for the environment.[118]

Where it is the case that 'green tariff' contracts are still more expensive than ordinary supply contracts, we might conclude that it is CSR concerns which are driving take-up, with the financial effects of the Levy exemption providing a marginal influence. At the same time, and although we received no evidence on this, we might speculate that the exemption could also function to draw attention to the possibility of choosing 'green tariffs', and that this would prove effective for organisations already searching for CSR opportunities.

85. Regarding the exemption's impacts on the construction of new renewables, the evidence is that it has had minimal effect. EDF Energy's memo put it bluntly: it "has had little impact on incentivising the development of new projects because the CCL exemption for renewables does not provide a significant financial incentive to develop new projects".[119] This does not, of course, mean that there are not other powerful incentives for adding new renewables capacity; indeed, EDF made clear that the Renewables Obligation (RO) does have a significant effect. But EDF made it equally clear that the reason why the RO is effective in this respect, while the Levy exemption is not, is because the financial incentive offered by one dwarfs that offered by the other—by around 10 to one. Furthermore, EDF said that they would not take the financial effects of the Levy exemption fully into account when assessing the economic case for building new renewables capacity, because there was uncertainty over how long both the Levy and with it the exemption would remain in operation.[120] Although the 2007 Pre-Budget Report confirmed that the Climate Change Levy and Agreements would be extended from 2010 to 2017, it did not confirm that the exemption would also be continued. In any case, EDF said that confirmation until 2017 was still of little use: "even at 2017 you are only looking at about six years of an operational life and that is if you are deciding to build one today. It would not be a significant factor in investing in renewables."[121]

The exemption on combined heat and power has had limited effect

86. The impacts of the exemption for CHP appear to be very similar, and for the same essential reasons. The Combined Heat and Power Association (CHPA) stated that the Levy exemption was an important benefit to existing CHP operators. However, on the construction of new CHP capacity, Graham Meeks of CHPA concluded: "The Climate Change Levy itself is probably only having a modest impact."[122] According to CHPA's analysis, in the period since the operation of the exemption could have had a noticeable effect, the amount of CHP capacity in the UK has only increased by 5%.[123]

87. CHPA argued that the main reason for the modest nature of this impact was that the financial benefit provided by the exemption was simply too small. As they explained, building new CHP capacity involves "a higher capital cost investment to meet energy needs compared to simple boiler plant and taking grid electricity", and is thus highly sensitive to expectations of financial returns, from reduced running costs and selling surplus heat and power, over the long term. In recent years, energy price movements have made CHP plants less economic, thus increasing the importance of additional financial incentives such as the CCL exemption.[124] But according to CHPA, the exemption:

    […] is a relatively small amount of value that is being added, something as a maximum around £4.40/MWh of electricity generated against the wholesale price that is typically between £30-40. There is a general sentiment around the industry, and of course it does vary depending upon site and application, that in order to incentivise perhaps the sort of levels of investment the Government would be looking for we should probably need a level of incentive of something around £6-7/MWh.[125]

In addition, CHPA argued that the effect of the exemption was further weakened as the electricity generated from CHP plants was sold on via suppliers to final consumers:

    To realise the benefit one has to sell the power to somebody else who is paying the Climate Change Levy, thus realising the exemption. Passing any commodity through a series of hands to reach the end customer means that people take a margin on the way through, and so we see an erosion of the value to the person who is actually making the investment as we go through the supply chain. The practical effect is very limited.[126]

Both exemptions are compromised by the Levy discount for CCA participants

88. The effectiveness of the Levy exemptions has been further compromised by the way in which they interact with the Climate Change Agreements. Given that CCA participants already receive an 80% discount on the Levy in return for committing to meet their Agreement targets, the incentive provided by the exemptions from the Levy is for them significantly reduced. Graham Meeks of CHPA believed this had

89. This is especially unfortunate, given that CCA participants tend by their very nature to have large electricity bills, and thus might otherwise be more attracted by the Levy exemptions than other firms. It is worst for CHP, since this situation will tend not just to affect market pull from consumers of CHP electricity, but market push for providers of it. That is, where industrial firms use gas in CHP plant and sell surplus electricity to other users, they will benefit from the Levy exemption on the input fuel; but this benefit will be largely negated, since industrial sectors will also tend to be covered by a Climate Change Agreement, and thus already benefit from an 80% reduction on this input fuel.

90. It seems clear that the exemptions from paying the Levy on electricity from renewables and combined heat and power plants have had very limited effects on the construction of new renewables and CHP generation. Where the exemptions have had an effect in helping to increase business demand for supply contracts offering electricity generated by renewable sources, this can face the same problems widely reported as facing private consumers who switch to 'green tariffs' for their household supplies: power companies may simply brand as 'green electricity' a certain amount of their supply contracts, up to the proportion of their overall output already generated by renewable sources, without this necessarily having any real effects on the building of new renewable sources. (They should, of course, be increasing this construction as a result of another instrument, the Renewables Obligation; but this does not necessarily justify charging higher prices for a 'green' brand of supply contracts.)

91. What effects the Levy exemptions do have are reduced almost entirely in respect of companies covered by Climate Change Agreements, since they already benefit from an 80% reduction in the Levy in any case; this affects CHP particularly badly. We recommend the Government re-examines ways in which to increase the incentives to install CHP plant, or buy CHP electricity from outside sources, available for industrial firms within CCAs.

112   With the exception of large-scale hydroelectric power plants with a declared net capacity of more than 10 megawatts. Back

113   All input fuel used in electricity generation from fossil fuels is also exempt from the Levy; the reason for this is to avoid business effectively being charged twice, both paying the Levy rate on the electricity they buy, and paying more to electricity suppliers to cover the amount of Levy they would have to pay on the coal, oil or gas used in their power stations. Back

114   BERR, UK Energy in Brief, July 2007, p 29 Back

115   Combined Heat and Power Association, Back

116   Ev 120 Back

117   Ev 59 Back

118   Carbon Trust, Energy Saving Factsheet - Climate Change Levy, p 4 Back

119   Ev 59 Back

120   Q105 Back

121   Q106 Back

122   Q105 Back

123   Ev 62 Back

124   It becomes economically more attractive to build new CHP capacity when the price of market price of gas falls below that of electricity; this makes it more profitable for plants which generate heat and power from burning gas to sell surplus electricity to other users. Since 2000, however, gas prices have risen above electricity prices (see Figure 1), reducing the potential profitability of CHP plants.  Back

125   Q105 Back

126   Q105 Back

127   Q110 Back

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