Environment, Climate Change and Land Reform Committee

Meeting date: Tuesday, August 11, 2020

Official Report 583KB pdf

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Climate Change Act 2008

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Greenhouse Gas Emissions Trading Scheme Order 2020

Under agenda item 3, the committee will take evidence on the Greenhouse Gas Emissions Trading Scheme Order 2020. I welcome the Scottish Government officials who are joining us, and I thank them for their work in briefing the committee over the summer and for their flexibility in meeting us today. Ross Loveridge is the head of the heat demand and carbon markets unit in the consumers and low carbon division, Alice Mitchell is the head of carbon markets and Euan Page is the UK frameworks policy manager in the constitution and UK relations division.

My first question is to Euan Page. How has the Scottish Government been involved in the process of developing the UK ETS?

There is no need for you to turn your microphone on and off; broadcasting staff will do that for you.

Good morning. I apologise to committee members who heard some of this at the informal briefing session earlier in the summer, but I will quickly recap the main points so that we are clear about how the ETS framework fits within the overall frameworks development process.

The approach to UK frameworks is agreed between the UK Government and the devolved Administrations. It is underpinned by a set of principles, which were agreed at the joint ministerial committee on European Union negotiations in October 2017, in order to develop common approaches to manage areas of policy in which devolved competence intersects with EU law. From an initial list of well over 100 potential frameworks areas, we are now down to a total of roughly 30 frameworks areas, of which a replacement for the EU ETS is one.

Frameworks have been developed through an agreed phased approach of policy development, and there has been a very strong focus on ensuring adequate parliamentary scrutiny as part of the finalisation of the frameworks. It is important to emphasise the JMC(EN) principles and the weight that those place on respect for devolution, the democratic accountability of the devolved institutions and the guarantees therein that frameworks will offer at least the equivalent flexibility to tailor devolved policy choices as is currently afforded by EU rules.

The frameworks process has been hindered by a range of factors. Twice in 2019, we had to shift to no-deal planning. We are currently working to the deadline of the transition period ending at the end of 2020, which was set by the UK Government against the wishes of Scottish and Welsh ministers. That places significant challenges on delivering a full frameworks programme before the end of the transition period, so the focus now is on ensuring that we have in place at least provisional arrangements across the board for all areas in which frameworks will still be required.

The EU ETS is one of seven frameworks—six of them apply to Scotland—that we envisage being agreed, finalised and fully operational by the end of the year. That framework is perhaps distinct, in as much as it is not affected by some of the concerns that have beset other frameworks areas in which, with the change of UK Government, there has been an increased appetite for diverging from EU rules. On that framework, we have a shared ambition across the UK Administrations for a UK ETS to slot into the EU ETS system. For that reason, we are not seeing the same challenges in relation to managing divergence across the UK as we are perhaps seeing in other frameworks areas. There is also the imperative of having a new system in operation from a second past midnight on 1 January 2021, because we need to have continuity, as my policy colleagues will explain in more detail.

That is where we are. As I said, the process has been beset by a number of setbacks outwith the Scottish Government’s control. Of course, Covid has had a significant impact on capacity across the Administrations. However, the ETS framework is very much on track. It is distinctive for the reasons that I have set out. As Ross Loveridge and Alice Mitchell will doubtless elaborate on at greater length, the policy detail that will inform the operation of the framework is very much tied up in the statutory instrument that the committee is scrutinising. Some frameworks do not require bespoke legislative underpinning, but this arrangement does. The policy detail will be in the SI. The framework outline agreement and concordat, the administrative arrangements and the statements of commitment to working together across the UK Administrations will underpin the legislative undertakings.

I want to bring in Alice Mitchell and Ross Loveridge. We have received a series of letters from the Cabinet Secretary for Environment, Climate Change and Land Reform, and we will be asking her about her views on all those matters.

It appears from her correspondence to us that there is one sticking point, and I would like some technical information on why it is an issue. The devolved Administrations want to be part of the UK ETS and have that link to the EU ETS, but there seems to be an issue with the proposed carbon tax, which the Scottish Government does not want. What are the technical issues with having the two proposed schemes? Who wants to answer that?

11:15  

Alice Mitchell and I will be a bit of a double act for this answer, if members are happy with that. In her letters on the negotiations about what would happen when we leave the EU ETS that the committee has received over the past couple of years, the cabinet secretary has been very clear about her concerns about the carbon emissions tax as an alternative to the UK emissions trading system. Both those approaches can set a carbon price; the UK Government has been very clear about the need to set a carbon price, as has the Scottish Government. As the cabinet secretary has said in her letters to the committee, the challenge lies in the extent to which those approaches fall within reserved or devolved competence. The order that the committee is considering is clearly within the scope of devolved competence, which is why the committee is scrutinising it as the main legislation makes its passage through the four legislatures. In contrast, a carbon emissions tax would be reserved to Westminster, using powers under the Finance Act 2020, which the UK Government introduced in 2019, which could be further amended if the UK Government chose to implement that approach.

There is a choice between the UK emissions trading system, of which the devolved elements would be largely accountable to the Scottish Parliament, and a carbon emissions tax that would not be accountable to the Scottish Parliament because it would be reserved. I cannot comment on the merits of either of those options, but the cabinet secretary’s concern is that both those options remain on the table, which means that while she, in good faith, is recommending that the Scottish Parliament approve the legislation for a UK emissions trading system, there remains a parallel proposal for a carbon emissions tax. The UK Government says that that proposal is there to cover eventualities and in case there is a need to establish a carbon price by an alternative route, but it is not clear to us why that would be needed, given that the UK emissions trading system could operate as a standalone system even if it was not linked to the EU system. Do you want to add anything to that, Alice?

I do not have much to add except to say that the two schemes are mutually exclusive—we would have one scheme or the other and we would not have both schemes running in parallel.

What interaction and consultation has there been with sectoral bodies and stakeholders in Scotland, such as the Scottish Environment Protection Agency, to inform the Government’s thoughts in this process?

SEPA has been working with the Scottish Government, the UK Government, the other devolved Administrations and the regulators throughout the development of the UK ETS policy. SEPA has been invaluable in providing technical expertise on the ins and outs of emissions trading systems, given that it has working knowledge of all the current technical rules that are being replicated closely in the UK emissions trading system. SEPA has been involved in working groups to establish the design for the UK ETS.

In May 2019, and over the summer, we ran a joint consultation with the three other Administrations for stakeholders on the policy options and design of a UK ETS. That concluded in August 2019. We held events throughout the UK to take stakeholders through the design of the UK ETS, including an event on 12 June in Glasgow, which was attended by 26 organisations, which is about a quarter of all Scottish ETS participants. That was quite a good turnout.

There were further events, and there was bilateral engagement across the UK with trade association groups and other fora.

The consultation was quite niche and technical, so the responses to it were predominantly from current EU ETS participants who have a vested interest in expressing views on the design of a replacement for that scheme. There were about 130 responses from across the UK. About half of those responded on a UK-wide basis, as current operators in the EU ETS. Only eight respondents gave a specific location and said that they were Scotland based, and among those the views were consistent with the general UK-wide view of the design elements of the UK ETS.

Overall, the responses were very supportive of the design of a UK ETS. There were a mixture of views on particular design elements; for example, the level of free allocation and how that is calculated. Those views were on subsets of the overall policy design.

This is one of the less contentious frameworks—as we have already been told—and there appears to be good working between the devolved nations and the Westminster Government.

There is a suggestion that carbon tax is still on the table and that it has been worked on in parallel. Is that the case, or is it there simply as a backstop—if I can use that word—or a fallback, given the very short timescale that there is to implement this potential new scheme? Considering that on 1 January we absolutely need some sort of continuity, is the carbon tax being worked on to the same extent as the scheme that we have in front of us at the moment?

Yes. The UK Government is at present consulting on the design of the carbon emissions tax. That consultation launched during July. Legislation is before the committee at present as far as the UK ETS is concerned. All four Governments are confident that the UK ETS can be established and operational by 1 January. The Government response makes that clear, and that is why ministers have laid the legislation in Parliament at this stage. An additional statutory instrument will follow on from that in the autumn.

The timetable that we shared with the committee when we briefed it back in June made clear that the legislation can be in place and the UK ETS established by 1 January 2021. Therefore, the question whether a carbon emission tax is a fallback in the event that the UK ETS cannot be established would have to be referred to the UK Government. That is because Scottish ministers are confident that the UK ETS scheme can come into force on time. That is why they have laid the legislation.

I have a few quite tightly focused questions on the mechanics of how all of this is going to work.

Do forgive me, I want to ask one very simple question to which there might not be an answer available: how many transactions do we expect to go through the UK ETS in a year?

When you say transactions, do you mean buying allowances?

There are two parts to the thing. There is the issuing of coupons to people in the market and there is trading. I am interested in the trading. I am trying to get a sense of whether we need computer systems or whether the trading level is such that we could have a ledger for someone to write the transactions in because there are only six a day. I have no sense of the scale.

I can answer on the information technology. We are developing a new IT system to manage the transaction business. It needs more than pen and paper. I do not know the exact number of transactions that currently occur in the EU emissions trading system, or how many occur in the UK portion of that, but we need what is called a registry to manage the transactions.

Some transactions come from operators and are for the allowances that they buy and need to meet their obligations to cover their emissions. Other transactions come from traders, which could be financial institutions wanting to hedge and buy or sell allowances. I can come back to the committee with more information about the breakdown of the proportions of transactions that are from financial institutions and from operators.

That would be useful. I am not asking for an exact number, but the order of magnitude would be useful as I have no sense of the territory.

I will move to more substantive matters. The UK market is significantly smaller than the EU market. Do you have a sense of how much that will increase the spread between bid and buy, and therefore what the friction will be in what will inevitably be a smaller market? Do we have any understanding of that?

I will ask the other part of my question so that we can deal with it all at once. To what extent will we get to a position where we can trade across the boundaries between the UK and EU emissions trading systems? It strikes me that it is like two countries exchanging currencies. In some cases—as with Nepal and India—the exchange rate is fixed. In other cases, the rate is set by international markets. How will trading work and what will it do to the bid and buy ratio?

Those are good questions: they go into the dynamics of the market. It is important to say that the market has not started yet. As you will have read in the Government response and in the impact assessment, one of the greatest concerns of the four Governments is to ensure liquidity in the market from day 1 and to enable the market to go through its own process of price discovery so that it can understand the most cost-effective price for reducing emissions.

The UK piloted the world’s first emissions trading system in 2002 and has been a leading player in the EU ETS since then. We have learned that it takes time for markets to get on their feet and this ETS is being designed with that in mind. One key thing is to ensure that there is liquidity in the market from day 1, so that it can run as a standalone system, so, to respond to your question about linking and what that would mean, new rules are being put in place for auctioning. Learning from the experience of the EU system, there will be market stability mechanisms to provide market certainty and protect against persistently low or high prices. Reserve prices will be put in place for some of the reserved aspects that will be taken forward by the UK Government through the Finance Act 2020. That will ensure that minimum prices are set for emissions and that they do not fall so low that they do not incentivise emissions reduction.

It is important to say that all that is also subject to review. The proposal in the legislation makes it clear that there will be two reviews of the whole scheme, in 2023 and in 2028, which will look at all aspects of the design of the system in order to ensure not only that it is running correctly and fluidly, but that it is incentivising emissions reduction in line with our wider targets.

11:30  

With regard to the question of the link and what that will mean, as we have said before, the scheme has been designed to mirror the rules in the EU system that we are leaving. It is a good starting position, because we are already close to the EU scheme; we will have the same scope, sectors and rules around the share of allowances that are allocated for free or auctioned and the same thresholds for smaller emitters. The intention regarding the link with the EU system—again, a reserved matter for the UK Government, which is carrying that negotiation forward—is that we would have fungibility of allowances, so that they could be traded and mutually recognised between both markets. As the markets were linked, the ambition is that we would see a convergence between the two markets: the prices would converge and the allowances would be shared between both. I hope that that covers the points that you raised.

It probably does so from officials, but when we hear from the Cabinet Secretary for Environment, Climate Change and Land Reform at the beginning of September, she might expect to hear more questions; you might take note of my statement to that effect.

Finlay Carson, you were going to ask about the carbon pricing mechanism, but could you continue your questions on the next theme that you wanted to ask about?

One of my questions—about the implications of the UK scheme not linking to the EU scheme—has been mostly answered.

Given the different ambitions that the UK and Scotland have for emissions reductions, what would be the implications of a UK-wide cap?

That is a good question. The cabinet secretary was very clear in her consideration of a UK-wide cap in the discussions with the other Governments that, on leaving the EU, it was important to ensure market stability. That is a big share of our emissions, as we set out in June. Around a quarter of all Scotland’s emissions are covered by that. The shares vary between the different parts of the UK. We must make sure that we are able to create a mechanism that ensures emissions reduction in line with the cap and that that cap continues to decline year on year, so that the absolute amount that can be emitted overall across the whole phase of the scheme, out to 2030, falls in line with our emissions targets that we set for the ETS and that it is able to maintain industrial competitiveness and address the risk of carbon leakage. We have spoken before about the risk of carbon leakage from outside the EU, which has clear measures in place to protect against it, and also the risk of carbon leakage from the UK to other countries, and indeed within the UK, which has different industrial compositions. In Scotland, now that our large fossil-fuel power stations have closed, there is more of an emphasis on the energy intensive industrial sector being the main sector that is covered by the emissions trading system, whereas in other parts of the country there is as much of an emphasis on power generation.

Trying to get that balance right across the UK is challenging, but we believe that balancing the ambition for climate with competitiveness is consistent in part with the just transition principles in the Climate Change (Emissions Reduction Targets) (Scotland) Act 2019, as well as balancing the range of considerations of the target-setting provisions of the act. Clearly, those provisions are for a different purpose, but we see in them the importance of looking at the impacts on industry and the economy, as well as on emissions.

It is important to say that our climate targets are set across the economy as a whole—they are based on actual emissions levels from all sectors. We have never expected all sectors of the economy to decarbonise at exactly the same time as each other. In a conversation with the UK and Welsh Governments and the Northern Ireland Executive, it is about making sure that we have a balance that works across the UK and is consistent with our net zero ambitions and those of the UK, which will ultimately reflect the fact that there are different compositions of the traded sector in each of our countries. The proposals that we have put forward reflect that need for compromise between the four Administrations in terms of our policy objectives.

Is there a level of confidence in the Scottish Government that the initial cap, which is set at 5 per cent less than what the UK share would have been if it was in the EU ETS, will still be adequate to align with our emissions targets? If not, what mechanisms are there in the legislation to allow that to happen? One of my colleagues will touch on exemptions and potential thresholds for smaller emitters, but is there capacity or flexibility in the legislation to allow that alignment to happen?

In the response, we have been very clear that the cap that has been set in the order is an interim cap until we receive further advice from the Committee on Climate Change, which, unfortunately, will not come until the end of this year. As the cabinet secretary set out in her correspondence, the challenge with setting a cap that is consistent with net zero has been that the four Administrations have not yet received the advice from the Committee on Climate Change on what a net zero-consistent trajectory should be.

As we have set out in the Government response, the first approach is to set a cap that is tighter than what the EU cap was, and then make a clear commitment to review the cap within nine months of receipt of the advice from the Committee on Climate Change—which we expect will be at the end of December this year—and legislate for the change to the cap to bring it into line with net zero no later than 2024, but with an ambition to do so by 2023. It will take time to consult with participants on what the adjustment should be and then legislate. The quickest that we could make changes to the legislation after receiving the CCC advice at the end of December this year would be during the 2023 calendar year.

I have only a brief question, which is supplementary to Finlay Carson’s point about the fact that, in Scotland, we have a robust 2030 emissions reduction target and our net zero emissions target is 2045, rather than 2050. Can any light be shed on how comfortable the Scottish Government is with those divergences, in particular with regard to the 2030 target, given how quickly it will come upon us?

To go back to what Euan Page said at the start, it is important to have a legislative mechanism. The legislation is there and is within the competence of the Scottish ministers. We have to work by agreement across the four Governments, but we are accountable as a Government to the Scottish Parliament for the setting of the cap and any amendments to the legislation.

That commitment to the review will have to take into account the fact that we have our own 2030 target in Scotland. We expect that when the Committee on Climate Change gives its advice on that, the advice will be consistent with the fact that there are different targets in place for climate change in the four nations of the UK. We expect that to be reflected in the CCC’s advice. Given that the period to which this phase of the ETS applies takes us to 2030, the advice of the CCC and our response to that will have to be mindful of the target.

I want to ask about derogations and exemptions. I am talking about not the ultra-small emitters—those that emit less than 2,500 tonnes of carbon a year—but the space between 2,500 tonnes and 25,000 tonnes a year, where individual emitters can apply for a derogation. There might be some encouragement for them to reduce emissions in that space, but they are not part of the trading mechanism.

I have a particular concern about waste incinerators, which are automatically exempted, as there are a lot of development applications for waste incinerators around Scotland at the moment.

There are also quite a few applications in my region and around Scotland for smaller gas peaking plants in the electricity system. I am interested to know whether those will be captured by the ETS or whether they fall within the derogated threshold of carbon emitters of under 25,000 tonnes. If a number of applications for gas peaking plants go through, that could collectively add up to quite a large amount of carbon being emitted into the atmosphere, and if the plants are not captured by the trading scheme, what will be the impact?

It would be interesting to hear your reflections on how you have drawn that line and on the number and type of derogations that will come through.

We have hit a problem, because Euan Page has lost connection. Perhaps Alice Mitchell will step in.

May I ask for clarification of the meaning of “gas peaking plants”? Do you mean stand-by generators that produce electricity in case of a shutdown of the grid?

That is another way of describing them. I think that many of the applications that are coming through would provide that function in the electricity system, but they would also provide regular production of electricity outside of that back-up facility. They definitely emit carbon.

The design of the small emitter scheme is based on the current small emitter opt-out scheme that is available under the EU ETS. Such plants can opt out of the trading portion of the scheme, but they still have an obligation to reduce their emissions. To opt out of the trading, they have to agree instead to meet a target to reduce their emissions, and that target is set on the same trajectory as the ETS cap. It will be the same principle in the UK system.

The companies in the small emitter opt-out will still have to reduce their emissions. If they do not manage to reach their annual target, enforcement action is available to regulators, which will ensure that they are subject to equivalent measures that incentivise them to reduce their emissions.

I do not know any instances at the moment of gas peaking plants in the current EU ETS small emitter opt-out scheme. Participation in the EU ETS is based on a threshold of a 20 megawatt hour capacity. That will be the same for the UK ETS. If those plants are combustion sites with capacity smaller than 20 megawatt hours, they will not even be captured by that threshold.

At the moment, waste incineration is not included in the scope of the EU ETS. We seek to maintain that approach to ensure a smooth transition to the new market for now, but we can reassess once the market is established.

Does that answer your question?

Yes. I presume that you will take guidance from the UK Committee on Climate Change on any future revision of the scope of the scheme.

Yes.

11:45  

I have a few more questions, although you have perhaps answered some of them. I have heard a lot of positivity around 1 January being the date when the scheme will be operational. If there are concerns—for example, about the potential for delay—this is your opportunity to voice them before a parliamentary committee. I will take your silence as complete assurance that the scheme can and will be delivered on 1 January.

The SI that we are considering today is the cornerstone of the UK ETS and the timing of laying it is designed to ensure that the structure is in place for January next year.

As you might be aware, this SI is one element; there are others. A second SI will be made under the powers in the Climate Change Act 2008, which will be subject to the negative procedure. There will also be a couple of SIs under the Finance Act 2020, to add in the reserved fiscal elements of the UK ETS, which relate to the power to auction allowances and the Financial Conduct Authority being given a role in overseeing the financial transactions. The two Finance Act SIs are due to be laid in Westminster later this year. All four bits of legislation should—I hope—be in place and the UK ETS should be operational in January.

On the IT infrastructure, we are building a new registry, as I said, which in effect is like a banking system to keep track of allowances and transactions. That is being built as we speak.

The system for use in relation to matters such as stakeholders’ annual compliance with the scheme will predominantly be needed from 2022, because people will report emissions on a calendar-year basis and then have three or four months to undertake activities—there will be a bit of a time lag. There is therefore a bit more time to get that system fully operational, but the UK ETS structure will be there from January.

Will there be an additional resource requirement for SEPA in rolling out the system? Is SEPA adopting a full-cost-recovery model?

As I said, we are working closely with SEPA, which has been helpful in providing technical expertise—the Scottish Government has supported SEPA to provide that expertise over the past couple of years. The complication is that, if we remained in the EU ETS, changes that that scheme is undergoing would come into place in 2021. Because we are replicating those changes in the UK ETS, we have to take on the new activities. Therefore, regardless of the current situation, there would have been new activities for SEPA in 2021.

We are still discussing with SEPA what it will require in that regard. Given that no member state has experience of the new EU ETS activities, it is difficult to predict the level of additional resource that will be required, but it is not thought to be significant.

Is SEPA adopting full cost recovery?

Sorry—yes. As you might be aware, SEPA is currently consulting on its charging scheme for a UK ETS, to replace its existing charging scheme for the EU ETS. The new scheme will be on the same principle, in that it will recover the costs of SEPA’s activities in regulating the scheme as well as the maintenance costs of the IT scheme that SEPA uses to keep track of permits and annual reporting. The consultation sets out a proposal on charges that involves covering the costs for SEPA.

I will bring in Claudia Beamish for a quick question before I go to Angus MacDonald.

I will build on what has already been discussed. Could the current economic conditions result in an oversupply of allowances and a weak carbon permit price in the UK ETS? You touched on what might happen because of that, but do you have any specific comment on the current economic conditions?

The level of the cap is set not only to reflect the need for compliance in relation to people who are in the scheme having enough allowances to meet their emissions but to recognise that it is a new market. In particular, electricity generators tend to exhibit certain behaviours in markets because they need to manage their on-going long-term contracts—for example, they offer energy contracts a few years in advance at a certain price. Therefore, they tend to hedge, as it is called, and buy their carbon emission allowances for several years, so that they can offer certainty on their carbon price as part of their contract. The cap is set to allow those companies to re-establish that hedging position, and that will likely mean that demand for allowances is not necessarily reflective of the actual level of emissions in the initial few years.

So the current economic conditions are not something that we should be concerned about in relation to hedging?

I am afraid that I do not really know the answer to that. It is difficult to predict the behaviour of the market and how significant that is, which is the reason for setting a cap that gives a bit of leeway to accommodate that. The auction reserve price is one of the in-built mechanisms to manage a surplus. If the price is particularly low, obviously that would not incentivise reduction, so an auction reserve price of £15 has been set as the minimum price at which allowances can be sold.

The rules for auctioning are being adjusted compared to those under the EU ETS. Under the EU ETS, allowances are auctioned every fortnight but, if 100 per cent are not sold, the whole auction does not succeed and all allowances are put back into the pot for auctioning next time round. In the UK system, we will limit the ability to roll them over to only four successive auctions, at which point, if they remain unsold, they will be taken out and put into a reserve. That will reduce the surplus allowances that are continually added to the remaining amount being auctioned.

I turn to the public-facing concordat. The cabinet secretary’s letter to the committee on 2 June refers to the development of the

“public facing concordat between the Ministers from all four administrations”

that would accompany the framework outline agreement. Has the public-facing concordat been completed? If not, when does the Scottish Government expect those documents to be available and shareable with the committee?

Euan Page would ordinarily have answered that but, as he has disappeared, I am happy to do so.

That is a good question about the public-facing concordat. It is still being developed alongside the framework outline agreement as part of the process agreed between the four Administrations under the wider JMC(EN) rules. As Euan said at the start, the order in council that is before the committee provides clarity on ministers’ role and accountability to the Scottish Parliament. Any changes to the ETS would require legislation and there would be accountability to the Parliament.

The framework outline agreement and the concordat will describe how the Administration will oversee the ETS in operation. As Euan said, that includes things such as governance, dispute resolution, the practicalities of managing the legislation once it comes into operation and how we will develop the policy for any future change that might require changes to legislation. There is also the review period, which I mentioned earlier.

The plan is for the public-facing concordat to be made available alongside the framework outline agreement once we move into phase 4 of the JMC(EN) agreed processes for common frameworks. My understanding is that it will be made available so that the Parliament can consider it but, because of that wider process, I cannot say when.

Okay. We look forward to receiving it in due course.

Thank you for your patience.

As we have no more questions, I thank the Government officials for their time. At a future meeting, we will hear from the cabinet secretary to discuss the issues and we will formally consider the order.

That concludes the public part of our meeting. At our next meeting, on 18 August, we will take further evidence on the UK Withdrawal from the European Union (Continuity) (Scotland) Bill.

11:56 Meeting continued in private until 12:26.