3 The rationale for energy subsidies:
supporting infant and low-carbon industries |
30. Energy subsidies are often used as a means
of promoting 'infant industries' (paragraph 12), and in particular
renewable energy technologies. In this Part we examine two aspects:
the UK's support for particular energies overseas, and the Government's
support for renewables and other specific industries within the
Subsidies, overseas aid and export
31. In our 2011 report on Overseas Aid, we criticised
DfID support for World Bank aid programmes which supported fossil
fuel projects. In
our current inquiry, DfID informed us that the World Bank's approach
to energy lending is now guided by its July 2013 Toward a Sustainable
Energy Future for All: Directions for the World Bank Group's Energy
Sector document, which allows "financial support for
greenfield coal power generation projects only in rare circumstances.
Considerations such as meeting basic energy needs in countries
with no feasible alternatives to coal and a lack of financing
for coal power would define such rare cases."
The Government's recent announcement about ending support for
coal power plants abroad was couched in similar terms.
32. The aid programmes of developed counties,
sometimes involving renewable energy projects, may provide assistance
for countries which are at the same time subsiding fossil fuels.
Globally, fossil fuel subsidies are at least five times higher
than the $100bn pledged to be made available in climate change
finance at the 2009 UN Copenhagen climate change conference.
Shelagh Whitley of ODI identified five countries (China,
Egypt, India, Indonesia and Mexico) which were among both the
biggest recipients of climate finance and the biggest providers
of fossil fuel subsidies to their consumers.
DfID told us, however, that the Government does not make the UK
aid programme conditional on an absence of fossil fuel subsidies:
There is not a direct correlation between our support
for climate finance and whether or not a country has fossil fuel
subsidies or not. Having said that, all the programmes that we
do support are to do with enhancing access for the poor and are
based exclusively on renewables and other forms of non-carbon
related energy. ... it is a series of programmes that are about
carrot to help countries to work out how best to remove fossil
fuel subsidies rather than stick in the sense of seeking to condition
aid or support in some way to compel them to do so.
We make the assessment on the merits of the proposal
for support and whether or not that meets the country's own stated
objectives to decarbonise or seek a lower carbon, more climate
resilient pathway. We do not ... make a linkage in any specific
way to whether or not that country has fossil fuel subsidies.
When applications are made for support through our
bilateral programmes and those we support through the World Bank
then, yes, we do look at the programme as a whole to see whether
or not that makes sense and whether or not it is indicative of
a country making a serious attempt to move towards a lower carbon,
more climate resilient development pathway. There is not, however,
any explicit benchmark or algorithm that takes into account the
fossil fuel subsidies or the extent of those which then conditions
whether or not we provide that support.
33. Our witnesses from Global Subsidies Initiative
and Overseas Development Institute did not favour overseas aid
being blocked when potential recipient countries had fossil fuel
subsidies. Some subsidy might be justified where it is targeted
at the poorest, rather than as blanket support.
Shelagh Whitley of ODI wanted greater transparency on where potential
overseas aid is going to countries with fossil fuel subsidies,
to help reduce cases which "are working full-time against
34. In our 2011 Overseas Aid report we also criticised
UK Export Finance's lack of support specifically for renewables
rather than fossil fuel export projects.
The OECD and IEA regard export guarantees as subsidies.
Platform highlighted UKEF's support for oil and gas contracts
in Nigeria, Russia, Urals and Brazil; and diplomatic and military
support for Nigeria, Iraq and Russia, which they labelled as subsidy.
(UKEF provided us with a list of 'energy' exports and projects
supported over the last 5 years.)
Oil and Gas UK, on the other hand, highlighted that UKEF are a
net contributor to the Treasury.
35. The Energy Minister told us that the Export
Investment Guarantees Act 1991 does not allow UK Export Finance
to discriminate in its support between different classes or types
of export: "It would be unlawful for the Secretary of State
simply to declare a blanket ban on certain types of investment.
... I think the objective is the right one, but we are constrained
by the existing legislation."
David Godfrey, the UK Export Finance chief executive, assured
us that a lack of green projects supported by the organisation
was not the product of any discrimination on its part. The countries
to which such technology is exported, he suggested, do not tend
to require export support.
He highlighted that the OECD Common Approaches guidance, which
the UK follows, requires export projects to be assessed in terms
of their social and human rights, but also their environmental,
impacts. The Government's
2010 announced prohibition on supporting exports of 'dirty' fossil
fuel technology is
defined in terms of meeting World Bank standards.
36. DfID should make,
and publish, an assessment that compares its aid expenditures
and the extent of fossil fuel subsidies for each aid-recipient
country, and UK Export Finance should similarly provide a comparative
analysis of export finance support and fossil fuel subsidies.
DfID should then include these analyses in a revision of its Environment
Strategy, along with the two departments' assessment of why continued
aid and export support in each case overrides the need for eliminating
fossil fuel subsidies in those countries.
Renewables and the need for time
37. The main subsidy for large-scale renewable
energy sources in the UK is currently the Renewables Obligation
scheme which requires suppliers to provide a certain proportion
of their electricity from approved renewable sources. Small scale
generators receive a fixed price feed-in tariff for their generation.
As a result of the Government's recent electricity market reform,
large scale renewable and non-renewable generation below a certain
carbon intensity will instead receive an overall reward for electricity
generation based on a contract for difference that will provide
variable payments, representing the difference between an agreed
'strike price' and an average 'reference' price representing what
would otherwise be obtained by selling electricity at market rates.
If the reference price exceeds the strike' price, the difference
will be repaid by the generator. The strike price and the length
of the contract will vary according to the type of energy technology.
38. While such renewables subsidies form part
of a move to increase the proportion of energy from renewable
sources and contribute to EU and national emissions reductions,
the Government is resisting European proposals to increase the
renewables targets. In our recent report on carbon budgets, we
noted how the EU
has agreed to raise its 2020 20% emissions reduction target to
30% if other developed countries and the more advanced developing
nations pledged comparable emission reductions.
As we reported in October 2013,
the European Commission has been consulting on a 2030 Framework
for Climate and Energy Policies, intending to publish at the
end of 2013 new targets for 2030.
The Government wants the EU to adopt a 50% emissions reduction
target for 2030 in the context of a global deal, or 40% without
a deal, but it did not support a proposal for a separate EU renewable
energy target because it believed that that would compromise member
states' flexibility over how they secured a least-cost decarbonisation.
39. Renewable UK believed that until there is
a "correct" carbon price, subsidies to many renewable
technologies will remain "necessary and indeed desirable".
However, different technologies, they told us, needed to be supported
for different timescales:
For the time being, subsidies [for Renewables] remain
essential, however our members are determined to reduce costs
to a point where, in a market underpinned by a strong carbon price,
no subsidy is required. However, it is important to understand
that the varying technologies will achieve this on different time
Subsidies for renewable technologies could potentially
become harmful if these where pursued indefinitely and did not
change to reflect the dynamics of the market. This is exactly
what happened with feed-in-tariff for roof mounted PV systems
in 2010 .
40. Shelagh Whitley of ODI emphasised the importance
of building-in processes to limit the duration of all types of
What seems to be missing for existing subsidies and
how they are structured is around this question of monitoring
and reporting and around the question of exit and failure. I do
not know ... what are the best ways to put in place sunset clauses,
but planning for an exit, planning for flexibility, planning for
modification, building that around a system where you have monitoring
and reporting so that you can make decisions around milestones
seems to make a lot of sense.
Alan Simpson emphasised that "subsidies should
be treated as transitional mechanisms rather than permanent support,
addressing market defects and moving the energy market from its
current structure towards the energy systems that will replace
41. DECC calculate 'levelised costs' for each
energy sector, representing the ratio of the costs of a generic
power plant in that sector to the amount of electricity expected
to be generated by it.
DECC expected the levelised costs of onshore and offshore wind
and solar PV energy generation to fall, as "reflected in
the proposed strike prices for such technologies", and that
"we might expect some projects within these technologies
to reach parity with wholesale electricity prices in the latter
half of this decade or 2020s."
The Energy Minister noted that costs were falling for solar power
we might have to ask why there should be any kind
of supported strike price for it after the current levy control
framework period. Almost all of [renewables], with the exception
of biomass and energy from waste, show the prices digressing over
the period of the levy control framework.
42. Renewables energy has an
important part to play in delivering the UK's emissions reduction
targets, and allowing the UK to play a full role in tackling climate
change. Subsidies for renewables are, in turn, an essential lever
to provide certainty to industry and drive investment in those
technologies. While the Government has a helpfully positive
view on the need to increase the level of emissions reduction
ambition in the EU, it should rethink its hostility to a separate
continued target for the deployment of renewables. Even without
such a continued EU target, however, the Government should be
ready to fully use the scope for renewables subsidies to help
meet our climate change obligations.
43. On 21 October 2013, the Government announced
the parameters of a deal with EDF for the construction and operation
of a new nuclear plant at Hinkley Point in Somerset, including
the £92.50/KWh contract for difference charge for the electricity
it would provide.
44. Back in February 2013, the Secretary of State
for Energy and Climate Change told the House:
... Under [the Electricity Market Reform], ... new
nuclear will receive no levy, direct payment or market support
for electricity supplied or capacity provided, unless similar
support is also made available more widely to other types of generation.
By similar, we do not mean the same. Whether similar support is
being provided must take account of the material circumstances.
It is not a mechanical exercise; it is a matter of sensible judgment.
It is obvious that the characteristics of a small onshore wind
farm are very different from those of a large offshore wind farm
and, indeed, those of a nuclear plant. ... These different characteristics
are likely to require differences in the support provided under
our electricity market reform.
... It is right that new nuclear power will be entitled
to benefit from Energy Bill measures such as contracts for difference
and investment contracts. ...
... I do not think that what is needed is a line-by-line
comparison of the terms of each contract. That is not what our
policy says or requires. In fact, there are likely to be variations
in CFD designs between one technology and another, and perhaps
also between different projects within the same technology. What
is important is that the terms agreed deliver a similar result
across technologies and projects, and that they result in a proper
allocation of risk. In addition, each contract will need to deliver
value for money for the consumer and be compatible with state-aid
rules. A contract with a nuclear developer that does those things
would be compatible with our no-subsidy policy.
Accordingly, DECC and the Treasury told us that:
new nuclear will receive no levy, direct payment
or market support for electricity supplied or capacity provided,
unless similar support is also made available more widely to other
types of generation. New nuclear power will benefit from any general
measures that are in place or may be introduced as part of wider
reform of the electricity market to encourage investment in low-carbon
generation. This is about creating a level playing field for all
forms of generation, not subsidising nuclear.
45. Dr William Blyth had a different view. He
told us, before the Hinkley Point announcement, that the contact
for difference would constitute a subsidy:
not only because of the raised price compared to
market levels, but also because long-term fixed price contracts
with reliable counterparties allow companies to borrow money at
lower interest ratesa particularly important factor for
capital intensive projects like nuclear plant.
It is likely that in the early years of operation,
this market price support will constitute a substantial subsidy
compared to the cost of the cheapest alternative (i.e. gas-fired
plant), but in the long run, the subsidy element is not so clear.
46. When we questioned the Energy Minister on
30 October about the Hinkley Point deal, he maintained that the
project would not represent subsidy as defined by the Government,
nor even that it would be subsidised on "similar" terms
to the subsidies available to other energy sectors. Instead, the
Government would provide the contractor with a "support mechanism"
These are market based support mechanisms designed
to facilitate the earlier introduction of high cost low carbon
technologies that the market would not otherwise have been able
to finance as quickly as we need them.
The deal will now be scrutinised by the European
Commission for potential state aid implications (paragraph 9).
47. The energy minister told the House on 23
... The Energy Act 2008 requires operators of new
nuclear power stations to have arrangements in place, before construction
begins, to meet the full costs of decommissioning and their full
share of waste management and disposal costs.
The cost of decommissioning, DECC told us,
would not be subsidised by the Government because "the intention
is that the decommissioning arrangements will completely fund
all the waste that is created by that plant", for "the
lifetime of the plant in terms of operation and decommissioning""the
entire cost of decommissioning the reactor and dealing with the
Secretary of State told the House that the clean-up fund to pay
for eventual decommissioning and a share of the waste management
costs would account for around £2 of the strike price.
48. The Energy Minister also stated on 23 October
... The waste contract will, at the outset, set a
cap on the level of the waste transfer price ... The cap will
be set at a level that reflects the Government's current analysis
of risk and uncertainty around waste disposal costs and gives
a very high level of confidence that actual cost will not exceed
the cap. The Government accepts that, in setting a cap, the residual
risk that actual cost might exceed the cap is being borne by the
Government. Therefore the Government will charge the operator
an appropriate risk fee for this risk transfer.
Similarly, there will be a £1.2bn cap on the
nuclear incident liability which, the Minister told us,
was also not a subsidy because the developer will be charged a
"risk fee" on "commercial terms" for the Government
still having a residual liability. This arrangement, the Minister
told us, was an "insurance policy" rather than a subsidy.
49. The duration of the payments under the contract
for difference for Hinkley Point will be 35 years, or 60% of its
60-year expected operating life. That, the Secretary of State
told the House, would be "proportionally similar to the length
of the [contracts for difference] that are being offered to most
Gordon Edge of Renewable UK had a different view:
Government is taking a much longer term view of the
nuclear side than it is for renewables. [Renewables] are being
given some foresight at 2020 but they are signing deals for nuclear
for 2023 and potentially beyond. So we think that is a bit of
a mismatch in terms of commitment to the different sectors and
we would like to see much more commitment to our sectors beyond
2020 in order to have parity.
50. Although the scale and duration of the Hinkley
Point project was "qualitatively different", the Minister
told us, overall the support was "similar" to that provided
for other energy sectors.
The Secretary of State said that "the price agreed for the
electricity is competitive with the projected costs for other
plants commissioning in the 2020s, not just with other low-carbon
alternatives, but also with unabated gas".
51. The Hinkley Point C deal
will be scrutinised by the European Commission for state aid implications.
It makes no sense to claim that a subsidy applicable to more than
one technology therefore does not constitute a subsidy. It is
already clear that new nuclear is being subsidised. The contractor
for Hinkley Point will be able to use the guaranteed strike price
for the electricity generated to raise capital at lower cost.
It is debateable which of the various other Government-termed
'support mechanisms' and 'insurance policies' also constitute
subsidy. Even in terms of the Government's 'similarity' definition
of 'no public subsidy for new nuclear', there are aspects of support
which are not 'similar' to that provided for other types of energy,
notably on decommissioning and waste.
Contracts for difference and capacity
52. The regime established by the electricity
market reform envisages a strike price (paragraph 37) and 'contracts
for difference' for electricity produced by low carbon generators,
alongside a 'capacity market' to provide guaranteed incentives
for the construction of fossil fuel plants to bidders for electricity
supply contracts. The Government's intention for the former is
to move to a "technology-neutral competitive process as soon
as reasonably practicable", with ultimately no need to issue
contracts for difference: but in the meantime, with technologies
at different rates of development, this would be "preceded
by a technology differentiated competitive process".
The difference between the strike price and the reference price
in the proposed electricity market system (paragraph 37) points
to an inevitable but variable subsidythe price the generator
receives in excess of the prevailing market pricecomplicated
only by the theoretical possibility that generators may have to
pay back that 'subsidy' if the reference price exceeds the strike
price. Renewable UK were content to acknowledge that the contacts
for difference strike prices for renewables were subsidies.
Dr Blyth told us that for new nuclear whether the strike price
represented subsidy would only be established with the passage
of time. There
is no reason to believe, however, that the relationship of the
reference price to the strike price over the long life of nuclear
contracts for difference will be such that the principle of variable
but real subsidy will not also hold as far as nuclear is concerned.
The Nuclear Industries Association though saw the arrangements
as addressing a market failure, providing "enablers to facilitate
the UK's wider energy policy".
53. The first capacity auction will be run in
2014, for delivery in 2018-19.
Whether the capacity payments regime would constitute subsidy
depends on whether they over-compensate producers and whether
they are fairly available for all appropriate types of energy.
Dr Blyth told us that he would not regard them as a subsidy, but
rather as "a pricing mechanism, ... a way of providing payment
If the market is competitiveand it is a big
ifplayers in that market will recoup their costs either
through the capacity payment or through the energy payment, or
a combination of the two. In a competitive market, the combination
of the two would cover their short-run marginal cost. ... Whether
that works out in practice in a slightly less than competitive
market is another issue, but that is not a subsidy issue.
Gordon Edge of Renewable UK explained how any assessment
of whether capacity payments would constitute a subsidy would
not be straightforward:
In theory, it ought to be a zero sum game, in that
what is paid out in capacity payments ends up lowering the wholesale
price of power and therefore it is a recycling of money. I don't
think that is entirely true. There will be some hysteresis in
all of that and you will end up with more money going through
the capacity mechanism than you save through reduction in wholesale
price. But I think it could be seen as a cost of moving to a system
where there is a high proportion of high capital cost, low running
cost, low carbon generation sources that require a lot of flexibility
at the margins in order to cope with their variability or indeed
their inflexibility, as nuclear is. So we need to think of it
as a system cost. Whether you regard that as a subsidy, I would
have to go and think about the philosophy of that.
The Government expected "the net cost to consumers
... to be lower than the gross cost of the [capacity] auction
as the capacity market will result in lower wholesale prices than
would have otherwise been the case."
54. Where the capacity payment regime more clearly
constitutes subsidy is in the restricted availability of the payments
essentially to one type of energy. The Energy Minister considered
that capacity payments would not be a subsidy because they would
"not [be] a support mechanism for any one technology",
but he acknowledged that in practice the "majority"
of the payments would be for gas-fired power.
Gordon Edge told us that "the capacity mechanism is too closely
designed as a subsidy for new gas-fired plant when it should be
thinking much more widely about how we provide flexibility and
response to the system as a whole".
In practice, of the 'eligible technologies' listed in DECC's October
2013 Electricity Market Reform: Consultation on proposals for
it is clear that energy storage participation will be minimal
because capacity payments will only be available to non renewable
technologies not receiving Renewable Obligation or contract for
difference payments, coal plants will not be able to participate
since most existing plants will be required to close from 2016
under the terms of the Large Combustion Plant Directive, and it
will not be possible to build new unabated coal plants because
of the emissions performance standards set out in the Energy Bill.
Demand side reduction measures have been excluded from the 2014
capacity auction, as have interconnectors. The capacity payments
regime was another case, the Minister told us, of "an insurance
premium" rather than a subsidy.
55. The capacity payments regime
will constitute a subsidy for gas-fired electricity generation
because in practice it is the only technology that will be eligible
for the payments when the capacity contracts are deliverable in
Oil and gas
56. Using the OECD 'producer support' calculation
methodology, subsidy includes various tax allowances, such as
'field allowances', that can be set against petroleum revenue
tax (although not tax allowances which allow exploration costs
to be immediately offset against revenues).
There was some argument, however, about whether the generally
higher starting rates of corporation tax and petroleum revenue
tax levied specifically on North Sea oil and gas should be taken
into account in calculating the net effect of field allowances.
57. Dr Blyth pointed out that all oil and gas
producing countries levy taxes or royalties on production, to
"gain value from the resources being extracted".
The tax system for the North Sea provides a mechanism for the
State to "sell" the national asset to the extractive
standard rate of petroleum revenue tax therefore "defines
the 'normal' baseline tax rate for oil production in the UK".
58. The Government did not regard field allowances
In the case of oil and gas the Government has introduced
field allowances for more challenging categories of field that
are economic, but commercially marginal at the high rate of tax.
Such fields are relieved of tax of 32% for a certain portion of
their incomebut they still pay ring fence corporation tax
at 30% for this portion, higher than the mainstream corporation
tax rate. Field allowances do not reduce the cost of oil to consumers;
rather increase what is extracted from the UK continental shelf.
This oil and gas fiscal regime policy ensures the
Government maximises the economic production of oil and gas in
the UK, without giving undue support to otherwise uneconomic production.
For that reason, field allowances cannot be seen as a subsidy.
The Minister told that "if [North Sea oil and
gas companies] are paying a tax higher than other businesses are
paying, it cannot be a subsidy. It cannot be both a subsidy and
a tax, can it?"
59. In a similar vein, Oil & Gas UK saw subsidy
in terms of "the balance between the taxation collected ...
and the amount of value that is transferred from the taxpayer
back to these particular elements of the energy sector".
Accordingly, "allowances which reduce taxation rates to incentivise
activity, and that remain set at such a rate that the effected
sector remains a net contributor to the public purse, do not constitute
They considered that the higher starting point of tax for oil
companies should be taken into account when assessing subsidy.
Oil and Gas UK differentiated measures which underwrite the cost
of an activity from a tax which is applied on profits "once
all costs have already been paid".
Platform disagreed. They, like Dr Blyth, emphasised that "these
[North Sea] taxes reflect the fact that the fossil fuel companies
have been granted a right to exploit a resource that is scarce
in the UK, for example, oil and gas reserves. ... These special
taxes ... arise due to the special circumstances of natural resource
60. Field allowances for North
Sea oil and gas do not fully offset relatively high starting rates
of corporation tax and petroleum revenue tax. The allowances nevertheless
represent a subsidy because the higher tax rates compensate for
the use of state-owned fossil fuel deposits.
61. The Treasury announced tax concessions for
shale gas exploration costs in July, reducing the rate from 62%
to 30%. There is clearly no rationale for subsidy on the grounds
of supporting low-carbon technologies. Shale gas therefore provides
a case study for whether subsidies are appropriate for supporting
a new industry. The minister told us:
[Fracking] is new to this country. I think it compares
much more readily with offshore exploration for oil and gas so
the Chancellor is now consulting on a similar form of field allowance.
Again, that would not bring it down below the tax rates paid by
the rest of British industry.
As the Energy and Climate Change
Committee reported in 2011,
hydraulic fracturing and horizontal drilling are both techniques
that have been present in the UK for many years. They are not
new technologies. Fracking is not a technology warranting financial
support to become viable and competitive, and on that basis it
does not warrant subsidy through a favourable tax treatment.
66 Environmental Audit Office,
Fifth Report of Session 2010-12, The impact of UK overseas aid on environmental protection and climate change adaptation and mitigation,
HC 710 Back
Ev 139, paras 11 Back
Time to change the game: Fossil fuel subsidies and climate, op
cit; Q51 Back
ODI, At cross-purposes: subsidies and climate-compatible investment
(April 2013), page 10 Back
Qq 304-306; Ev 139, paras 5 and 9 Back
The impact of UK overseas aid on environmental protection and climate change adaptation and mitigation,
op cit, paras 70-71 Back
Ev 129 ; Q213 Back
Ev 132 Back
Q307 (See also Ev 132, paras 2 and 4) Back
Government, The Coalition: our programme for government (May 2010),
Q308; Ev 139 Back
Environmental Audit Committee, Fifth Report of Session 2013-14,
Progress on carbon budgets, HC 60, para 22 Back
ibid, para 23 Back
European Commission, A 2030 Framework for Climate and Energy Policies
(March 2013) Back
Progress on carbon budgets, HC 60, op cit, para 23 Back
Ev 103, paras 34-35 Back
Ev 103, paras 6-7 Back
Ev 103, para 35 Back
Ev 125, para 1.3 Back
HC Deb, 14 October 2013, col 431W; DECC, Electricity generation costs 2013
(July 2013), Annex 1 Back
HC Deb, 14 October 2013, col 431W Back
HC Deb, 21 October 2013, col 23 Back
HC Deb, 7 February 2013, cols 488-9 Back
Ev 110, paras 93-94 Back
Ev 64, para 2.3.3 (Gordon Edge of Renewable UK made a similar
point (Q200)). Back
HC Deb 23 Oct 2013, col 200W Back
HC Deb, 21 October 2013, col 24 Back
HC Deb, 23 Oct 2013, col 201W Back
Qq255, 256, 271-273 Back
HC Deb, 21 October 2013, col 24 Back
Qq256, 257 Back
HC Deb, 21 October 2013, col 25 Back
Ev 110, para 30 Back
Qq155, 160 Back
Ev 64, para 2.3.3; Qq24, 47 Back
Q157; Ev 102, para 5 Back
Ev 110, para 69 Back
Ev 110, para 71 Back
DECC, Electricity Market Reform: Consultation on proposals for implementation
(October 2013), page 152 Back
Ev 64, para 2.2 Back
Ev 64, para 2.2 Back
Ev 110, para 10 Back
Ev 110, para 113 Back
Ev 107 Back
ibid (Without mentioning it by name, Oil & Gas UK refer to
the effect of the 'Laffer Curve'; in economics theory, where a
tax cut results in more tax revenue because of the increased business
activity it triggers.) Back
Q290 (Oil and Gas UK also regarded this as a new industry in the
UK context (Q211)). Back
Energy and Climate Change Committee, Shale gas, Fifth Report
of Session 2010-12, HC 795 Back