CONFIDENTIAL
Walking the carbon tightrope:
Energy intensive industries in a carbon constrained world
FINAL REPORT
Prepared for:
The Trades Union Congress and
Prepared by:
Orion Innovations (UK) Ltd
Date: 26 March 2014
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world
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Tel: +44 203 176 2721 Email: info@orioninnovations.co.uk
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Contents
1
Executive summary ................................................................................................ 3
2
Acknowledgements ................................................................................................ 9
3
Introduction ........................................................................................................ 10
4
The UK energy and emissions policy landscape ........................................................ 14
5
Steel sector case study ......................................................................................... 27
6
Heavy clay ceramics sector case study ................................................................... 34
7
Mineral products sector case study ......................................................................... 44
8
Paper sector case study ........................................................................................ 52
9
Conclusions and recommendations ......................................................................... 57
1
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Glossary
BCC
British Ceramic Confederation
BIS
Department for Business Innovation and Skills
BOS
Basic Oxygen Steelmaking
CCA
Climate Change Agreement
CCC
Committee on Climate Change
CCL
Climate Change Levy
CCS
Carbon Capture and Storage
CfD
Contracts for Difference
CHP
Combined Heat and Power
CHPA
Combined Heat and Power Association
CM
Capacity Mechanism
CO2
Carbon dioxide
CPF
Carbon Price Floor
CPI
Confederation of Paper Industries
CPS
Carbon Price Support (under the CPF mechanism)
DECC
Department of Energy and Climate Change
EAF
Electric Arc Furnace
EDR
Electricity Demand Reduction
EEF
Engineering Employers Federation
EIIs
Energy Intensive Industries
EIUG
Energy Intensive Users Group
EMR
Electricity Market Reform
EU ETS
EU Emissions Trading System
FiT
Feed in Tariff
FiT CfD
Feed in Tariff Contracts for Difference
GDP
Gross Domestic Product
GVA
Gross Value Added, the value of goods and services produced in an area, industry
or sector of an economy
GW
Gigawatts
GWh
Gigawatt hours
LCF
Levy Control Framework, a Treasury cap on how much money can be levied on
consumers’ energy bills
LEC
Levy Exemption Certificate
MPA
Mineral Products Association
MW
Megawatts
MWh
Megawatt hours
NER
EU ETS New Entrants Reserve
Ofgem
Office of Gas & Electricity Markets
RO
Renewables Obligation
ROC
Renewables Obligation Certificates
TUC
Trades Union Congress
2
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
1
Executive summary
Energy intensive industries1 (EIIs) are walking a tightrope from a high to a low carbon economy.
Government policy should, we argue, enable the transition rather than add to its perils.
Yet these heavy energy users form the bedrock of the UK manufacturing sector and are vital to our
successful transition to an energy and resource efficient economy. They produce primary inputs for
much of what we manufacture and consume, and have been clearly shown to contribute significant
sums to the social and economic fabric of the country,2 including:

160,000 directly employed skilled workers, with four times that number in supply chains.

A combined turnover of £95bn or 3% of UK GDP.
Together they also account for over 50% of industry-related emissions and, in order to contribute
to the UK’s legally binding carbon targets, are expected to deliver reductions of 70% or more from
2009 levels by 2050.
Government policies aimed at reducing carbon emissions from industry rely heavily on measures
that both enhance energy efficiency and put a price on industry’s carbon emissions. The TUC and
Energy Intensive Users Group (EIUG) support this objective and the contribution that is required
from heavy energy users.
However, there is considerable concern that, despite industry delivering substantial energy and
carbon savings over recent decades through investment and innovation, the cumulative impact of
energy and climate policies is now putting extraordinary pressure on these industries, and
reducing their capacity to invest in the UK. In particular, unilateral UK policies risk distorting
international competition and increase the likelihood of carbon leakage – the loss of jobs,
investment and carbon controls to competitors with weaker, or no, climate change policies.
The government responded to these concerns raised by industry and trade unions with a
compensation package of £250 m announced in Budget 2011 for the period 2013-2015, boosted
by a further £150 m and extended to 2016 in Budget 2013. By December 2013, the ETS
compensation scheme had paid out £18 million to 29 companies in the energy intensive industries
sector.
Table 1 provides an overview of policies, proposed support packages, and their impact on heavy
energy users.
Industry and the TUC have welcomed the package but remain concerned that the support provided
is too short term and narrow in scope, and not on a scale comparable with that provided by our
European competitors. Furthermore, there is no compensation as yet for the passed through cost
to industry of the Renewables Obligation or the UK-specific carbon price floor.
Thus the intense debate between Government and industry over the means and necessity of
mitigating the impact of energy policy on energy intensive industries continues. This report aims to
contribute to that debate by asking whether the scale and scope of the current industry support
packages and the timescales over which they are provided are appropriate and what their impact
on investment decisions are likely to be.
In order to do this, the report looks at four case studies in detail:



Steel: an electro-intensive UK steel company that is part of a Europe-wide business group,
with competition for capital and day to day operating costs within the group and high
visibility of the impact of policies on UK operations relative to other European jurisdictions.
Ceramics: the heavy clay ceramics sector, which has not historically been exposed to
extensive international trade, but is showing significant up-lift in imports in recent months.
Cement and lime: sectors within the mineral products industry where we assess the impact
of government policy on the climate for investment in these capital intensive sectors.
1
Primarily iron and steel, cement and lime, ceramics, chemicals, glass, industrial gases, non-ferrous metals, pulp and paper,
and coke and refined petroleum products
2
Building our low carbon industries: Economic, employment and fiscal benefits of securing the energy intensive industries in
the UK; Orion Innovations report prepared for the TUC, 2012
3
Walking the carbon tightrope: energy intensive industries in a carbon constrained world

Combined Heat and Power (CHP) generation: one of the primary options for industrial
carbon abatement, illustrated by a specific installation in the paper sector.
Key findings from case studies
Evidence from these four case studies suggests that well-intentioned energy and environmental
policies, and inadequate support packages, are adding significant cost to UK manufacture relative
to both EU counterparts and international competition.





Steelmaker Celsa, Cardiff, has shared insights from their European operations that show
that its UK plant is one of the most energy and labour efficient in Europe, but faces the
highest electricity prices within the Group. Planned unilateral UK climate change policies
and tariffs, such as Carbon Price Floor (CPF) and Contracts for Difference (CfD) are
expected to exacerbate this situation. This is undermining the long-term prospects of this
highly efficient, low carbon business.
Many electro-intensive ceramics companies have already relocated away from the UK due
to high electricity costs. Recent trade data suggests that heavy clay sectors, such as clay
roof tiles and bricks, previously less exposed to carbon leakage are now seeing significant
increases in imports. Uncompetitive energy prices, unpredictable future energy tariffs, lack
of access to compensation and gas supply insecurities have been cited as significant
contributing factors.
The mineral products cement and lime sectors, in common with most other EIIs, are
capital intensive and operate on long investment cycles. Policy uncertainty and support
mechanisms that extend no further that the current Treasury spending review period are
adding risk and discouraging investment. Rather than encouraging a transition to low
carbon technologies, the uncertain policy framework, unilateral burdens on UK producers,
and unrealistically short timeframes for support packages, are having a corrosive impact
on the investment climate and long term viability of these businesses. In particular, they
are stifling innovation and making offshoring of new investment a more attractive
proposition to multi-national parent companies.
Eligibility criteria for support packages are inappropriate. For example, although some
ceramics firms are the most electro-intensive in Europe, about 85% of energy demand
across the whole sector is supplied by gas. As eligibility is currently defined at a sectorwide level, these highly vulnerable installations are considered out of scope. Furthermore,
the use of policy impact costs as a proportion of Gross Value Added (GVA) to determine
eligibility for support discriminates heavily against companies and sectors that are more
labour-intensive, creating further unintended distortions.
Combined Heat and Power policy changes, in particular the removal of CHP Levy
Exemption Certificates (LECs) from the market and the imposition of the CPF from April
2013, have undermined incentives to deploy one of the most effective and proven means
of industrial carbon emissions abatement.
Government, industry, Trades Unions and trade associations have a common objective in
delivering a low carbon future that is affordable to both domestic consumers and industry.
However the challenge comes in putting this into practice, in ‘walking the carbon tightrope’
between creating the right environment to encourage investment in decarbonising energy supply,
and sustaining vital energy intensive industries in the UK. Both are needed in order to deliver our
low carbon future.
EIIs are generally mature, making use of similar manufacturing processes and technologies across
all countries. The responsible approach is therefore to ensure that UK heavy energy users:




Remain in the UK and do not succumb to carbon leakage;
Deploy the most carbon-efficient processes available to them;
Invest in innovation to reduce the environmental impact of their activities;
Have available to them, proven and commercially viable cross-sector solutions such as CHP
and carbon capture and storage (CCS).
4
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Most EIIs supply commoditised products to internationally competitive and price-sensitive
markets, and are highly capital-intensive, dependent upon long term fiscal and regulatory stability
in order to attract investment. Many are multi-national concerns, with inter-company competition
for capital and operational investment. Government policies therefore need to:



Ensure that energy prices faced by all levels of UK industry, and in particular EIIs, are no
higher than competitor nations in Europe and beyond, now and in the long term;
Deliver a long-term stable environment that encourages industry to invest in new plant,
innovation and emissions abatement, just as the Government is endeavouring to do for
nuclear and renewable energy sectors. Investment cycles for EII can be several decades in
length;
Encourage deployment of cross-sector carbon emissions abatement solutions such as CHP
and CCS.
Rethinking government policy
Given the insights gained from these case studies, we believe that there is a need for a
fundamental re-think of Government policies. Current policies have the perverse and unintended
consequence of undermining investment in UK industry and corroding international
competitiveness, and therefore result in carbon leakage.
Near-term measures to limit the adverse impact of energy and environmental policies on EIIs are
urgently needed in order to allow time for appropriate longer-term measures to be developed. In
particular, we would recommend that the Government:






Freeze the CPF at its current level. The near doubling of Carbon Price Support (CPS) rates
in 2014 and in 2015 is unaffordable, and in the absence of State Aid approval for a longterm durable compensation package, risks causing significant damage to the
competitiveness of UK electro-intensive industries. If state aid approval cannot be secured,
CPF should be abandoned.
Extend and widen the scope of proposed compensation packages for electro-intensive
installations. Eligibility for compensation should be determined at a company, rather than
a sector-wide level; and the duration of these measures should reflect the length of the
policy impacts that they are intended to mitigate and the investment cycles of the
industries concerned.
Exempt Combined Heat and Power from the CPS costs that it incurs on fuel used to
generate electricity. Given the need for significant investment in electricity generation, and
the proven efficiency benefits of CHP, industrial CHP should be encouraged. Exempting
CHP from CPS will compensate for the recent removal of LECs.
Consult with industry on the effects of the Renewables Obligation (RO), the main support
mechanism for larger scale renewable electricity projects in the UK, which also has a
considerable impact on industries’ costs.
Create a well-funded programme to support industrial energy efficiency, with incentives for
investment. The current reliance on driving energy efficiency through higher energy prices
risks carbon leakage if undertaken unilaterally in the UK.
Create a high level Energy Intensive Industries Council, with representation from industry,
trade unions and government, tasked with developing comprehensive long-term industrial
strategy to secure jobs, growth and the low carbon transition.
TUC response to Budget 2014 and next steps
The TUC’s Budget submission 20143 included all of the above recommendations for the energy
intensive industries. They are based on sound evidence. We argued that energy intensive
industries are walking a tightrope from a high to a low carbon economy. Government policy
should, we believe, enable the transition rather than add to its perils.
3
http://www.tuc.org.uk/sites/default/files/2014%20Budget%20Submission.pdf
5
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Has the government done all we could realistically expect in its £7 billion package of support for
energy intensive industries? For sure, the government knew it had to act.
The EEF’s recent Executive Survey4 showed that the most cited to risk to growth was “largely
related to the cost of energy.”
Whilst the Chancellor’s policy reforms were welcome, the TUC and industry have expressed real
concerns over residual disadvantages to UK businesses. One piece of grit is stuck in the machine:
the carbon tax at £18 a tonne of carbon. It still leaves our heaviest energy users at a
disadvantage. Frankly, we fear that the package doesn’t start soon enough or go far enough to
create an even playing field.
The Chancellor’s £7 billion package spreads over six years to 2020. As we showed in More German
Lessons5 (2013), over the period 2010-2012 Germany’s wide ranging support for its energy
intensive industries stood at 26bn euros, or some 8bn euros (£6.4bn) a year.
The EIIs package from the Chancellor includes 4 key initiatives:
1. Capping the carbon tax: The Carbon Price Support rate will be frozen at £18 per ton of
CO2 from 2016-2020. The government claims this will save all businesses (not just energy
intensives) £5.5 billion to 2020. However, both the TUC and EEF called for the carbon tax
to be frozen at its current rate. Why the delay? The Carbon Price Support rate in 2015/16
is already almost twice that originally intended (at £18.08 as compared with the 2011
indicative rate of £9.86).
This will constitute almost 10% of a large industrial user’s electricity bill. Government claims this
will save a mid-sized manufacturer almost £50,000 on their annual energy bill.
The carbon tax will still raise over £1.2 billion a year, and the Carbon Reduction Commitment a
further £1 billion. The government remains wedded to the carbon tax as a means to stimulate
investment in low carbon infrastructure. But capping the Carbon Price Support should be a prelude
to scrapping it.
Two further Budgets announcements are claimed to save “around £500 million a year from 201617”, or about £2 billion to 2020:
2. Renewable Obligation and the Feed-In Tariffs: new compensation from 2016 “worth
almost a billion pounds” will protect manufacturers from the rising costs of the Renewable
Obligation and the Feed-In Tariffs.
The Renewables Obligation (RO) is currently the main support mechanism for larger scale
renewable electricity projects in the UK. It is also arguably “the green levy” with the greatest
impact today for industry. So this new relief is unexpected and welcome. Yet the RO along with
small-scale feed in tariffs is costing steel maker Tata £10.50 per megawatt-hour (year from April
2014) for production in the UK, whereas competitors elsewhere in Europe will either be completely
exempt, or have their charges from equivalent schemes capped at €0.50 per megawatt-hour.
Similarly, as Walking the carbon tightrope shows, the pass through costs of the renewables
Obligation (RO) is currently costing steelmaker Celsa, based in Cardiff, an additional £8.66 per
megawatt hour (MWh) and the feed-in tariff a further £2.12/MWh. Celsa, an electric arc furnace
steelmaker using mainly recycled materials, is the largest producer of steel reinforcement in the
UK, and one of the most energy efficient in Europe.
4
http://www.eef.org.uk/NR/rdonlyres/E5073AE0-C126-46B3-A9A41FF43FD69C97/23666/EEFBudgetSubmission2014.pdf
5 http://www.tuc.org.uk/industrial-issues/energy/more-german-lessons
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world
So why the delay to 2016 in cutting the RO out of industry’s costs?
3. Extending the existing compensation scheme for energy intensive industries to
2020: providing support for a further four years to 2019-20 is welcome, but again, there
are reservations. To date, 65 companies have benefitted with support worth £38 million
from the first year of the scheme. As currently designed, this pattern suggests that
payments are unlikely to exceed £80m out of the £110m available up to 2015-16.
The scheme is patchy in coverage. New TUC research based on sector case studies suggests that
the government should widen the scope of proposed compensation packages for electro-intensive
installations in excluded industrial sectors. There are thus major concerns over whether the most
electro-intensive UK installations in ceramics, clay, minerals, glass etc. will receive any
compensation at all, as the Ceramics Confederation has said...
We would prefer the Chancellor to have signalled his intent to reform eligibility for compensation.
This should be determined at a company, rather than a sector-wide level.
Whilst we welcome the extension of the scheme to 2020, in reality, its duration should reflect the
much longer time span of the £multi-million pound investment cycles of the industries concerned.
Savings from Budget 2014 energy package in 2018-19
Average
Medium-sized
household manufacturer
Heavy
Typical
Industrial
compensated Ell
firm
Estimated total
£15
£50,000
£800,000
£6.25m
savings from package
in 2018-19
Source: Internal HM Treasury analysis
4. Combined Heat and Power (CHP) plants: The government has exempted from the
carbon price floor the electricity from CHP plants. This is also welcome. TUC research
shows that half of all paper making sites now make use of Combined Heat and Power units
on site. CHP offers the potential for significant emissions abatement. Around 6% of the
UK’s power needs are currently met by industrial CHP installations resulting in 15 million
tonnes of carbon emissions abatement per year. Vast untapped potential remains.
In its initial response to Budget 2014, the EEF6 said: “The Chancellor deserves a pat on the back.”
EIUG Director Jeremy Nicholson said: “These reforms will ease the pressure on Britain’s energy
intensive industries.”
The Budget statement claims that half of the firms that will benefit most are in the north of
England. Thousands of good jobs protected. That has to be the right place to start.
But for the TUC, the government has yet to create an ambitious, well-funded programme to
support industrial energy efficiency and low carbon technologies such as carbon capture, with
incentives for investment. The current reliance on driving energy efficiency and carbon reduction
through higher energy prices still risks carbon leakage if undertaken unilaterally in the UK. The
TUC will therefore continue to consult with industry and its affiliates in the energy intensive
industries to help provide the comprehensive strategy that meets the following key tests:
6
http://www.eef.org.uk/releases/uk/2014/Chancellor-delivers-on-his-word-for-manufacturers.htm
7
Walking the carbon tightrope: energy intensive industries in a carbon constrained world



Ensure that energy prices faced by all levels of UK industry, and in particular EIIs, are no
higher than competitor nations in Europe and beyond, now and in the long term;
Deliver a long-term stable environment that encourages industry to invest in new plant,
innovation and emissions abatement, just as the Government is endeavouring to do for
nuclear and renewable energy sectors. Investment cycles for EII can be several decades in
length;
Encourage deployment of cross-sector low carbon technologies, such as CHP and carbon
capture & storage systems.
8
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
2
Acknowledgements
This study was commissioned by the Trades Union Congress, in collaboration with the Energy
Intensive Users Group and its members. We would like to express our appreciation for the support
provided to us by TUC affiliates Community, Unite, GMB and Unity, trade associations and
individual companies in drafting this study, and in particular to British Ceramic Federation, Celsa
UK, Combined Heat & Power Association, Confederation of Paper Industries, Ibstock, Lafarge
Tarmac, Marley Eternit, Mineral Products Association, Northwood and WEPA, Singleton Birch and
UK Steel in preparing the individual case studies.
9
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
3
Introduction
3.1
What is the context for this report?
Energy intensive industries7 (EIIs) are walking a tightrope from a high to a low carbon economy.
Government policy should, we argue, enable the transition rather than add to its perils.
Energy intensive industries are the bedrock of the UK manufacturing sector and are vital to our
successful transition to a low carbon economy. The eight most energy intensive industries,
including iron and steel, cement and lime, ceramics, chemicals, glass, industrial gases, non-ferrous
metals, pulp and paper, and coke and refined petroleum products, have delivered substantial
energy and carbon savings over recent decades through investment and innovation. However,
they now face extraordinary pressures in coping with the cumulative impact of climate change and
energy policies. This report is focused on examining the impact of these policies and on
government support for these vital industries.
Both employers and trade unions in these manufacturing industries have a major interest in
securing their future within a low carbon economy, both to protect and promote reasonable terms
and conditions of employment for the long term, and achieve a “just and fair transition” for these
industries who make a significant contribution to the UK’s economy.
In order to meet the UK’s carbon targets, significant further reductions in emissions are required
across the economy. This will be achieved by decarbonising electricity generation, and from
making homes and transport more energy efficient. Industry, which accounts for approximately a
quarter of UK emissions, and the energy intensive industries (EIIs) in particular, will be expected
to make a substantial contribution too.
The UK is the first country in the world to have set legally binding carbon emission reduction
targets: at least a 34% reduction on 1990 emissions by 2020, and at least 80% by 2050. The
Climate Change Act of 2008 establishes a long-term carbon budget framework to achieve these
targets, and successive five year carbon budgets through to 2027 and beyond set out the manner
in which these will be met.
The energy intensive sectors produce primary inputs for much of what we manufacture and
consume, and contribute significant sums to the social and economic fabric of the country. Their
economic contribution includes:

160,000 directly employed skilled workers, with four times that number in supply chains;

A combined turnover of £95bn or 3% of UK GDP.
Together they also account for over 50% of industry-related emissions, and are expected to
deliver reductions of 70% or more from 2009 levels by 2050.
Government policies aimed at reducing carbon emissions from industry rely heavily on measures
that both enhance energy efficiency and put a price on industry’s carbon emissions. In practice, as
earlier research by the TUC and the Energy Intensives Users Group (EIUG) has shown, the
cumulative impact of energy and climate policies risks reducing the capacity of industry to invest,
and if applied unilaterally in the UK, will distort international competition and compromise the
sustainability of UK businesses.
In response to representations from industry and trade unions, in the Autumn Statement in 2011,
the Chancellor announced the government’s intention to implement measures to reduce the impact
of policies on the cost of electricity for the most electricity-intensive industries. A commitment of
£250 million was given for the period 2013-2015 to offset the impact of rising electricity prices,
including:

Up to £100 million in compensation for impacts from the Carbon Price Floor pass-through;
7
Primarily iron and steel, cement and lime, ceramics, chemicals, glass, industrial gases, non-ferrous metals, pulp and paper,
and coke and refined petroleum products
10
Walking the carbon tightrope: energy intensive industries in a carbon constrained world

£110 million compensation for indirect impacts of the EU ETS on electricity prices, in line
with European Commission state aid guidelines;

£40 million uplift on relief from the Climate Change Levy (from 65% to 90%) from April
2013.
In Budget 2013, this package was boosted by a further £150 million and extended to 2016.
In November 2012, further exemptions were announced to offset the additional costs arising under
the government’s Electricity Market Reform Contracts for Difference, provided for in the Energy Act
2013. Although the value of these exemptions has yet to be specified, the Committee on Climate
Change estimates that they will amount to around £350 million a year for electricity-intensive
industries in 2020.
The TUC has welcomed the shield provided by the government’s compensation package. However
it remains concerned that the support is too short term and narrow in scope, and not on a scale
comparable with that provided by our European competitors, notably Germany. Furthermore, there
is no compensation as yet for the passed through cost to industry of the Renewables Obligation or
the UK-specific carbon price floor.
Tata Steel UK Limited recently commissioned PricewaterhouseCoopers LLP (PWC) to assess the
current and potential future economic contribution of the Foundation Industries to the UK
economy. This study8 concluded: “Government policy in relation to climate change influences
energy prices and, therefore, potentially affects the competitiveness of the Foundation Industries.”
UK firms face higher incremental policy costs mainly due to renewable energy costs and the
carbon price floor. “Looking forward, the risk is that relatively high energy costs will adversely
affect the competitiveness of Foundation Industries in the UK as well as that of their potential
customers. This will impact negatively on UK firms’ ability to compete in both domestic and
overseas markets and deter foreign investors.”
These concerns are reflected in continued intense debate within and between political, industrial
and media circles over the means and necessity of mitigating the impact of energy policy on
energy intensive industries. For example:

December 2013, during a Westminster debate on the energy intensive industries and their
ability to compete globally in the face of rising energy prices, Paul Farrelly (Labour MP for
Newcastle-under-Lyme) said the government’s compensation package for energy
intensives should be linked to the Carbon Price Floor (CPF), so that it remains for the
duration of the policy, and so that its value would reflect the trajectory of the CPF. This
debate has continued fiercely with Energy Minister, Michael Fallon, speaking in February at
the City and Financial’s Electricity Market Reform (EMR) Summit ‘I don’t think it’s any
secret that the trajectory of the CPF is way out of line with the carbon price itself and there
are, as a result, significant difficulties for our industry’.

January 2014, Vince Cable responded to the Tata Steel commissioned Foundation Industry
report (PwC), by saying that the Government recognised that ‘rising energy costs pose a
major stumbling block for the competitiveness of British industry’, but he stopped short of
offering new government initiatives to tackle the problem.9

February 2014, continued lobbying of Government by EEF, the manufacturers’
organisation, to counter rising energy costs for EIIs, with demands to:10,11
o
Freeze and then reduce the cost of the unilateral Carbon Price Floor
o
Address the costs of the Renewables Obligation and Small Scale Feed in Tariffs
commit to extend all the measures in the current EII package for as long as is
required, up to and possibly beyond 2020/21.
8
Tata Steel’ Understanding the economic contribution of the Foundation Industries 2014
http://uk.reuters.com/article/2014/01/16/uk-cable-industrial-sector-idUKBREA0F13E20140116
10
http://www.eef.org.uk/releases/uk/2014/Budget-must-fire-starting-gun-on-plan-to-tackle-escalating-industrial-energycosts.htm; Executive Survey 2014, EEF.
11
Cornwall Energy, Energy Spectrum, 413, February 2014.
9
11
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
o

3.2
Commit to extend all the measures in the current EII package for as long as is
required, up to and possibly beyond 2020/21.
February 2014, a consensus that resolving state aid issues is now the key challenge to
address in order to ensure that proposed compensation packages are legitimate.12
What questions is this report looking to address?
The TUC and EIUG have commissioned a number of studies with the intention of enhancing the
evidence base on the impact of climate change and energy policies on industry, and catalysing
discussion between government, industry, and other stakeholders about the manner in which
emissions abatement targets can be realized without jeopardizing EIIs, employment and value
creation in the UK:

The Water Wye Associates report prepared for the TUC in 2010 showed that EIIs in the UK
were being placed at risk as a result of the cumulative impact of climate change policies,
and that these policies are undermining the capacity of industry to invest.

The Centre for Low Carbon Futures report prepared for the TUC in 2011 examined
technology options for realising significant decarbonisation of manufacturing, including the
use of carbon capture and storage; process change; and switching to the use of biomass.
This report reiterated concerns about the ability of EIIs to raise the funds and make the
necessary investment.

Building our low carbon industries, the Orion Innovations report prepared for the TUC and
EIUG in 2012, showed how investment in the most up-to-date and efficient plant is key to
delivering emissions abatement targets as well as securing energy intensive industries in
the UK. It also showed the significant economic, employment and fiscal costs of failing to
do so.
This study is intended to build on these studies and address the following key questions:

Will the scale and scope of the current industry support packages and the timescales over
which they are provided, be sufficient to support the UK’s EIIs during our low carbon
transition?

Is the Committee on Climate Change (CCC) assessment that the value of all these
measures is at the high end of the range of modelled profit impacts for electricity-intensive
sectors in 2020, fair? If so, is this sufficient? If not where are the key gaps?

If the sustainability of these businesses is dependent upon investment, how does the
longevity and political certainty of these measures impact upon investment decisions?
3.3
How has it been prepared?
This study does not seek to replicate the EII sector-wide economic modelling undertaken by the
Department of Energy and Climate Change (DECC), the CCC and others. Nor does it seek to
replicate industry’s response to government consultations. But it does seek to shed light on the
impact of policies and proposed support packages on four specific industries and sectors:
12

An electro-intensive UK steel company that is part of a Europe-wide business group. There
is competition for capital, and in day to day operating costs within the group and high
visibility of the impact of policies on UK operations relative to other European jurisdictions.

The heavy clay ceramics sector in the UK. This sector has not historically been exposed to
extensive international trade, but has experienced a significant up-lift in imports in recent
months.
Cornwall Energy, Energy Spectrum, 412, February 2014.
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world

Cement and lime sectors within the mineral products industry, in particular the impact of
policy and regulatory uncertainty on the climate for investment in these capital intensive
sectors.

Combined heat and power (CHP) generation, one of the primary options for carbon
emissions abatement and energy efficiency in EIIs. We illustrate this impact by looking at
a specific installation in the paper sector.
This study is not intended to be exhaustive. We have however found that there are common
themes across all four case studies. Furthermore, engagement with businesses, trade associations,
and TUC affiliates from other sectors, suggest that these case studies, and the resulting
conclusions and recommendations, are applicable to EII sectors as a whole.
3.4
Report structure
The report is structured as follows:
 Section 3: Introduction to the study, its background and methodology;
 Section 4: Overview of the current energy and environment policy landscape, as it relates to
EIIs, their energy use.
 Sections 5-8: Case studies.
 Section 9: Conclusions and recommendations.
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world
4
The UK energy and emissions policy landscape
4.1
Introduction
Mounting scientific evidence of potentially damaging anthropogenic climate change has resulted in
both national and international efforts to stem the growth in greenhouse gas emissions.
The UK Government has set the first four carbon budgets in law, covering the period from 2008 to
2027, by which time emissions will have been reduced by 50% relative to 1990. Multiple policy
measures have been put in place in order realise the UK’s overall energy policy objectives of
providing secure, low carbon and affordable energy. The EU has made a commitment to cut
greenhouse gas emissions to 40% below 1990 levels by 2030. In 2008, the UK broke new ground
in establishing the first legally binding commitment to reduce emissions by 34% by 2020 and 80%
by 2050.
The primary EU-wide mechanism is the EU emissions trading scheme (EU ETS), which promotes
industrial energy efficiency through the first international system for trading greenhouse gas
emissions allowances. This cap and trade scheme covers power stations, industrial plants and
aviation in 31 countries, including the UK.
Each EU Member State has its own additional domestic actions. In the UK, these include measures
to raise the share of energy produced from renewable sources, whilst simultaneously encouraging
energy efficiency.
As part of its EU obligations, the UK must obtain 15% of its energy consumption from renewable
sources by 2020, a fourfold increase on 2010. Electricity generation is expected to contribute most
to meeting this target, primarily through the use of wind and nuclear power generation, and
carbon capture and storage, although the Government has introduced incentives for the use of
renewable heat and obligations on transport fuel too.
Meanwhile, the UK is facing an energy security crisis in 2016, due to factors such as decades of
under investment in new power capacity, and the impact of compliance with EU environmental
regulations on existing coal fired generation. Around 12 gigawatts (GW) of coal and oil-fired power
generating capacity and 7 GW of nuclear power, accounting for a fifth of total UK electricity
generating capacity, are scheduled to close by the end of this decade. Ofgem, the energy-sector
regulator, estimates that around £110 billion needs to be invested in plants and networks. The
critical challenge for the Government is to encourage adequate investment in new low carbon
generating capacity, whilst ensuring continuing reliability of the power network, and maintaining
the cost competitiveness of UK business.
Since 2002, investment in renewable power generation has been incentivised by Renewable
Obligation Certificates (ROCS) which place an obligation on UK electricity suppliers to source an
increasing proportion of the electricity they supply from renewable sources. These costs are
passed through to domestic and industrial consumers.
The Energy Act 2013 introduced significant electricity market reforms intended to stimulate
investment in infrastructure and electricity generation capacity to deliver secure, affordable and
low carbon energy supply. These reforms include:

Contracts for Difference (CfD) with Feed-in Tariffs to stimulate investment by providing
stable long-term prices for low carbon electricity.

A Capacity Mechanism, intended to give investors the revenue certainty they need in order
to put adequate reliable energy generation capacity in place and protect consumers
against the risk of supply shortages.
In addition, the government introduced a Carbon Price Floor (CPF), a UK-specific tax on fossil fuels
used to generate electricity that is intended to provide a transparent and predictable minimum
price for carbon in the period to 2030.
Further mechanisms include:
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world

Feed in Tariffs (FiT), introduced in 1 April 2010, in order to encourage the uptake of small
scale renewable and low carbon electricity-generating technologies; and

the Climate Change Levy (CCL), and Carbon Reduction Commitment (CRC), intended to
encourage industrial energy efficiency and penalise emissions.
UK and EU-wide measures are summarised in Sections 4.2 to 4.8 and Table 1, below.
Each of these measures impacts upon EIIs, either in the form of climate levies, or in a pass
through of costs from their energy suppliers. There is growing concern that the cumulative impact
of these policy mechanisms will lead to carbon leakage, the transfer of business production to
countries with lesser and lower cost climate policies, as outlined in Section 4.9.
This has been recognised at both a national and international level and is reflected in the EU ETS
and EMR support packages that have been put in place or are in development, as described in
Section 4.10.
Subsequent sections of this report are focused on the questions listed in Section 3.2, namely
whether these support packages are adequate to militate against carbon leakage and the adverse
impact of policies on the long term sustainability of energy intensive industries in the UK.
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Table 1: Summary overview of climate change policies and support packages
Name
Description
EU
ETS
EU-wide cap and trade scheme for CO2
emissions from power plants; EIIs and
commercial airlines.
RO
Renewables Obligation suppliers must
source an increasing proportion of
electricity from renewable sources;
proved by acquiring ROCs, issued to
generators of accredited renewable
electricity.
Contracts for Difference (CfDs) provide
guaranteed stable long-term prices for
low carbon electricity.
CfDs
CM
CPF
FITs
CCL
CRC
13
14
15
The Capacity Mechanism (CM)
guarantees revenue to generators that
provide reliable electricity on demand.
UK-specific carbon tax on fossil fuels
used to generate electricity. Reflected in
a carbon price support (CPS) charge
collected via an extension to the CCL.
A guaranteed FITs for small scale
generators of low carbon electricity (< 5
MW)
Environmental tax on energy supplies to
industry (electricity, gas, LPG, coal and
other solid fuels)
Mandatory emissions reporting and
pricing scheme for large energy users
not covered by EU ETS or CCL
How energy intensive industries are
impacted
Companies receive or buy emissions
allowances which they trade as needed. At
the end of each year a company must
surrender sufficient allowances to cover all
its emissions, or risk heavy fines.
Suppliers pass the cost of compliance with
the RO on to customers through their
electricity bills.
Est. UK tax revenue13
2012/13
2013/14
£0.7 billion
£1.5 billion
£1.5 billion14
(2011/12)
Not available
Compensation
Compensation for indirect costs of EU ETS
(i.e. costs reflected in electricity prices) for
eligible sectors if indirect carbon costs
(combined cost of EU ETS and CPS) amounts
to 5% or more of GVA.
No compensation currently proposed.
Suppliers pass the costs of CfDs on to
customers through their electricity bills.
To be introduced 2014/15
The costs of capacity payments will be
recovered from electricity suppliers, who
pass these costs on to their customers.
Suppliers of fuel used to generate
electricity add CPS costs to their bills.
These are reflected in electricity prices.
EIIs pay for CPS in their electricity bills or,
for self-generation, in their fuel bills.
Suppliers pay the FITs to generators and
pass these costs on to customers through
their electricity bills.
Industry pays the CCL to energy suppliers
To be introduced 2014/15
for capacity delivery in
2018/19
(introduced
£0.6 billion
2013/14)
£0.15
billion15
(2011/12)
£0.7 billion
Not available
No compensation currently proposed.
£0.7 billion
Industry purchases allowances to cover
emissions.
£0.7 billion
£0.8 billion
EIIs eligible for 90% reduction on electricity
and 65% on other fuels if signed up to
Climate Change Agreements, which set
targets for energy efficiency.
No compensation currently proposed.
https://www.gov.uk/government/news/definition-of-environmental-tax-published
DECC, The Levy Control Framework, HC 815 SESSION 2013-14 27 NOVEMBER 2013
DECC, The Levy Control Framework, HC 815 SESSION 2013-14 27 NOVEMBER 2013
16
Under consultation. Potential exemption of
eligible industries from 80% of the pass
through costs of CfDs. Eligibility criteria may
be the same as for EU ETS and CPF.
No compensation currently proposed.
Under consultation but subject to state-aid
approval. UK Government may use same
eligibility criteria as for EU ETS.
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
4.2
European Union Emissions Trading Scheme
The EU ETS is the European Union's primary policy mechanism to reduce industrial greenhouse gas
emissions. The system, introduced in 2005, covers emissions of carbon dioxide (CO2) from power
plants, a wide range of energy-intensive industry sectors and commercial airlines. It works on a
'cap and trade' principle, in which a cap is set on the total amount of gas that can be emitted. This
cap is reduced over time so that total emissions fall. From 2013 onwards, it is intended that the
cap will reduce by 1.74% per year from power stations and industry, such that total emissions will
be 21% lower than 2005 in 2020. A separate cap applies to the aviation sector.
Within the cap, companies receive or buy emissions allowances which they can trade with one
another as needed. After each year a company must surrender sufficient allowances to cover all its
emissions, or risk heavy fines. If a company reduces its emissions, it can keep the spare
allowances to cover future needs or sell them to another company that is short of allowances. This
flexibility is intended to ensure that emissions are cut at least cost.
Participation in the EU ETS is mandatory, although only plants above a certain size are included.
Until now, the vast majority of emissions allowances have been allocated to power plants and
industry for free, with up to 10% auctioned in certain jurisdictions. It is the intention that
auctioning of allowances will increase during the third phase of the EU ETS which runs from 2013
to 2020, and that all free allocation will be phased out by 2027.
Power generators were required to buy all of their allowances from 2013, other than in eight
Member States that joined the EU post 2004 which have been allowed to give a decreasing
number of free allowances to existing power plants for a transitional period until 2019. Experience
shows that power generators have passed on the notional cost of allowances to customers even
when they received them for free. This will no doubt continue now that they have to pay for them.
In manufacturing, the transition to auctioning will be phased. Selected energy intensive industries
classified as being exposed to carbon leakage, were to receive 100% of an EU industry benchmark
allowance for free in 2013. In sectors not deemed to be at significant risk of carbon leakage,
installations which attain a predefined benchmark performance level were to receive 80% of the
allowances they needed for free in 2013, reducing to 30% in 2020. Installations falling short of the
performance benchmark receive a proportionately lower allocation of allowances.
In practice however, as the cumulative number of allowances due to businesses exceeded the
maximum amount available under the scheme, free allowances were reduced by a cross sectoral
correction factor. Therefore, sectors deemed to be at risk of carbon leakage in the UK will receive
about 95% of the EU industry benchmark in 2013, falling to about 82% in 2020.16 Sectors without
carbon leakage status will receive about 75% of the benchmark in 2013, falling to 25% in 2020
(Figure 1).17
The definition of those sectors deemed to be exposed to a significant risk of carbon leakage (see
Section 4.9 below) has been criticised by industries that do not meet the narrow criteria. Carbon
leakage status is currently being reviewed for the period 2015-19.
Allowances given to manufacturing industry for free are distributed to companies on the basis of
harmonised rules, intended to ensure that installations of a given type are treated equally across
the EU. Underpinning these rules are benchmarks for emissions performance, initially drawn up in
consultation with industry but now considered by some sectors to be over-ambitious, draining
funds for innovation.
Most EII companies will therefore have to purchase a proportion of their carbon emissions
allowances, regardless of carbon leakage status. It is intended that allowances not allocated for
free will be auctioned.
16
17
Based on cross sectoral correction factor
The exact amount depends on an cross sectoral correction factor
17
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 1: EU ETS % benchmark allocation for carbon leakage and non carbon leakage
sectors
While the EU ETS initially created a functioning market for carbon emissions, it now faces a
challenge. The economic downturn and an oversupply of carbon permits have created a surplus of
roughly two billion credits, which have pushed the price of carbon down from €30 per tonne at its
peak five years ago to around €5 per tonne today. Thomson Reuters Point Carbon (TRPC) reports
that the value of traded carbon permits and credits has fallen from £79.7bn in 2011 and £51.4bn
in 2012, to £32.3bn in 2013, a decline of 38%. This reflects both the fall in value, and a decrease
in the volume of emissions units changing hands, down from 10.7bn in 2012 to 9.2bn in 2013.
In the short term this surplus risks undermining the functioning of the carbon market. In the
longer term it could affect the ability of the EU ETS to meet emission reduction targets costeffectively. The Commission has therefore taken the initiative to postpone the auctioning of some
allowances, resulting in a ‘back-loading’ of 900 million tonnes of carbon permits that is intended to
bolster values near-term. As a longer term measure, in the next trading period from 2021 the
Commission proposes to establish a market stability reserve. This reserve is intended to improve
the system's resilience to major shocks by automatically adjusting the supply of allowances to be
auctioned. It would operate entirely according to pre-defined rules which would leave no discretion
to the Commission or Member States in its implementation.
A New Entrants Reserve (NER) of EU ETS allowances is a set aside for new operators or existing
operators who have significantly increased capacity. These operators must apply to the NER within
12 months of starting normal operation or following start-up of the new or extended activity, and
the application will determine the level of free allocation entitlement for the remainder of Phase III
to 2020. This adds uncertainty to investment decision-making, as outlined in the case study in
Section 7 below.
Industry bodies such as the EEF18 have argued that EU ETS, in isolation, restricts growth in carbon
efficient countries, inversely incentivising production in countries with no carbon standards and
hence has little or no impact on global emissions. It has called on the European Commission to
consider the case for moving trade-exposed, energy-intensive sectors to a single trading area
under the EU ETS, where the emissions reductions cap is adjusted in line with the emergence of
cost-effective abatement technologies, particularly in the continued absence of a global deal on
climate change.
4.3
Renewables Obligation
The Renewables Obligation (RO) is currently the main support mechanism for larger scale
renewable electricity projects in the UK. It is also arguably19 “the green levy” with the greatest
18
http://www.eef.org.uk/environmentblog/?tag=/EU+ETS
Hansard debate, energy intensive industries, 4 December 2013:
http://www.publications.parliament.uk/pa/cm201314/cmhansrd/cm131204/halltext/131204h0001.htm
19
18
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
impact today for industry. For example, along with small-scale feed in tariffs it has been estimated
to cost steel maker Tata £10.50 per megawatt-hour (year from April 2014) for production in the
UK, whereas competitors elsewhere in Europe will either be completely exempt, or have their
charges from equivalent schemes capped at €0.50 per megawatt-hour.
The RO places an obligation on UK electricity suppliers to source an increasing proportion of the
electricity they supply from renewable sources. This figure was initially set at 3% for the period
2002/03 and under current political commitments will rise to 15.4% (6.3% in Northern Ireland) by
the period 2015/16.
Renewables Obligation Certificates (ROCs) are certificates issued to operators of accredited
renewable generating stations for the eligible renewable electricity they generate. Operators can
trade ROCs with other parties and ROCs are then ultimately used by suppliers to demonstrate that
they have met their obligation.
Where suppliers do not present a sufficient number of ROCs to meet their obligation, they must
pay an equivalent amount into a buy-out fund. The administration cost of the scheme is recovered
from the fund and the rest is distributed back to suppliers in proportion to the number of ROCs
they produced in respect of their individual obligation.
For the purposes of government financial planning, the long-term value of a ROC is made up of the
buyout price, that is the payment avoided by the supplier for presenting ROCs to Ofgem, plus
10%. This is roughly £46 per ROC in 2013/14 prices.
The RO will be replaced by Contracts for Difference (CfD) under the Electricity Market Reform
(EMR) from 2017 onwards (see Section 4.4.1 below). For the first three years of the EMR, the
scheme will operate in parallel with the RO. The RO will remain open to new generation until 31
March 2017, allowing new renewable generation that comes online between 2014 (when CfDs
start) and 2017 to choose between the CfD and the RO. After this point, the RO will be closed to
new generation. All generation accredited under the RO will receive its full 20 years of support
until the scheme closes in 2037.
From 2027 the Department of Energy & Climate Change (DECC) will fix the price of the ROC for
the remaining 10 years of the RO at its long-term value and buy the ROCs directly from the
generators. This will reduce volatility in the final years of the scheme.
Suppliers pass the cost of compliance with the RO on to consumers through their energy bills.
4.4
Electricity Market Reform
The Government’s electricity market reforms, featured in the Energy Act, include:

A “contract for difference” feed in tariff (CfD) to provide low-carbon electricity generators
with a guaranteed price throughout the period of a long-term contract.

A capacity mechanism to ensure sufficient system flexibility is available to maintain reliable
supplies, especially during peak periods, as the amount of variable and inflexible lowcarbon generation increases.

A carbon price floor (CPF) to provide a transparent and predictable minimum carbon price
for the medium and long term.
These will be supported by:

An emissions performance standard (EPS) to limit how much carbon new power plants can
emit per unit of electricity generated.

Measures to incentivise Electricity Demand Reduction (EDR).

Measures to support market liquidity and access to market for independent renewable
generators.
The key policy instruments are described below.
19
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
4.4.1
Contract for Difference Feed in Tariff (CfD)
Contracts for Difference (CfDs) support investment in low carbon electricity generation by
providing a stable long-term price for low carbon electricity. The cost of these CfDs is passed
through to consumers via their electricity bills.
CfDs will support low-carbon generation by giving eligible generators increased price certainty
through a long-term contract. A CfD will largely remove exposure to volatile wholesale prices and
reduce investment risks. Generators will receive revenue from selling their electricity into the
market. In addition, when the market price is below the feed in tariff strike price they will receive
a top-up payment, funded by all suppliers, for the additional amount. Conversely if the market
price is above the strike price, the generator must pay back the difference: Figure 2.
The CfD feed in tariff is tailored to different generation types, with proposed strike prices ranging
from £55/MW for landfill gas to £305/MW for wave and tidal stream for the period 2014/15 to
2018/19. For a number of renewable technologies, the strike price will come down over time
reflecting the expectation that costs will fall through learning and volume deployment.
For the first three years of the EMR, the scheme will operate in parallel to the RO (See section 4.3
above). The proposed CfD strike prices for this period have been set so that they are comparable
to the levels of support available under the RO, adjusted to account for the greater revenue
certainty and shorter contract length provided by a CfD.
Figure 2: Illustration of the operation of the Feed in Tariff and Contracts for Difference
4.4.2
Capacity Mechanism
The Capacity Mechanism is a response to the risk to future energy security posed by the closure of
fossil-fuel based power generation and the addition of increasingly intermittent (wind) or inflexible
(nuclear) energy sources on to the system.
The Government recognises that the market may not make adequate capacity available without an
incentive, given that some power generation plant will need to provide stand-by as opposed to
base load electricity. The Capacity Market mechanism is intended to give investors the revenue
certainty they need in order to put adequate reliable energy generation capacity in place and
protect consumers against the risk of supply shortages. It does this by providing a predictable
revenue stream to providers of reliable capacity. In return they must commit to provide capacity
when needed or face financial penalties.
20
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
The Capacity Market will be triggered when National Grid believes that the availability of capacity
is less than the government’s reliability standard. National Grid will conduct this analysis four
years ahead of time and, if there is considered to be a shortfall, an auction will be run to secure
the required capacity. This may include demand-side response and storage, as well as generation.
The costs of the capacity payments will be recovered from electricity suppliers, who will in turn
pass these costs on to their customers.
DECC has confirmed that the Government will run the first Capacity Market auction in 2014 for
delivery of capacity from the winter of 2018/19, subject to the Energy Bill becoming law and
subject also to state aid clearance.
4.4.3
Carbon Price Floor (CPF)
The Carbon Price Floor (CPF) is a UK-specific carbon tax on fossil fuels used to generate electricity.
It came into effect on 1 April 2013 and provides a transparent and predictable minimum price for
carbon in the medium to long term. The government believes that this will address near term
limitations of the EU ETS and incentivise investment in low carbon technologies.
Industry bodies such as the EEF are concerned that unilateral measures like the Carbon Price Floor
will widen the gap further between costs faced by the UK’s electro-intensive industries and our
competitors, unless offsetting measures are provided.
The CPF mechanism is deployed through changes to the existing Climate Change Levy (CCL)
regime (see Section 4.6 below), by applying carbon price support (CPS) rates of CCL to gas, solid
fuels and liquefied petroleum gas (LPG) used in electricity generation. As oil is not subject to CCL,
the carbon price floor for oils is being achieved through reform of the fuel duty regimes, and in
particular changes to the relief on oil used in electricity generation.
The CPF was set at £15.70/tCO2 in 2013. The government proposed that it would follow a straight
line to £30/tCO2 in 2020, rising to £70/tCO2 in 2030 (real 2009 prices). The CPS will be
determined by the difference between the EU ETS and CPF rates for carbon emissions: Figure 3.
Cornwall Energy estimate (based on gas conversion factors and standard efficiencies) that a gasfired power station will be paying about £1.85/MWh on input fuel in 2013-14, rising to £3.56/MWh
in 2014-15 and £6.80/MWh in 2015-16. By 2020-21 with a carbon cost of £30/t, the tax on
electricity production from a gas station could reach £10.25/MWh in 2009 prices if (as appears
likely) EU ETS carbon prices do not rebound.20,21
The CPF, more than any other EMR policy mechanism, has faced significant criticism for the impact
that it is likely to have on the competitiveness and sustainability of UK industry relative to the EU
and rest of the world.
20
Cornwall Energy, Energy Spectrum Issue 403, 25 November 2013
A Strategy for Coal in the UK 2013: Managing the transition to meeting a decarbonised energy mix utilising coal with carbon
capture and storage. A discussion document from the Coal Forum Working Group, November 2013. Presented to Energy
Minister Michael Fallon MP in January 2014.
21
21
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 3: Illustration of the carbon price support mechanism (in real 2009 prices) 22
4.5
Small scale Feed in Tariff (FiT)
Feed in Tariffs (FiT) were introduced on 1 April 2010 and replaced UK government grants as the
main financial incentive to encourage uptake of small scale (5 megawatts (MW) or less) renewable
and low carbon electricity-generating technologies. These include solar electricity (PV), wind
turbines, hydroelectricity, anaerobic digesters and micro combined heat and power (CHP).
The FIT scheme provides a guaranteed tariff payment on both generation and export of renewable
and low carbon electricity. The scheme is open to any businesses, communities and individuals
that install small scale renewable and low carbon energy systems and is available through selected
licensed electricity suppliers.
4.6
Climate Change Levy (CCL)
The Climate Change Levy (CCL), an environmental tax on energy supplies to industry, was
introduced in 2001. It is intended to encourage greater energy efficiency and lower energy use by
increasing the effective price of energy.
There are two rates of Climate Change Levy; the main rates of CCL and the Carbon Price Support
(CPS) rates of CCL as described in Section 4.4.3 above.
Exceptions to the regime ease the CCL's impact on energy-intensive business sectors. Since
introduction of the CPF, they are eligible for a 90% reduction for electricity and a 65% reduction
for gas, LPG, coal and other solid fuel if they sign up to industry-wide Climate Change Agreements
which set challenging targets for improving energy efficiency.
In the March 2011 Budget, the Chancellor announced that the Climate Change Agreements
scheme would be extended until 2023 and the existing 54 participating sectors would continue to
be eligible for the scheme and the Levy discount. This extension was intended to provide industry
with more certainty to invest in energy efficiency measures with longer payback periods.
From April 2014 some mineralogical and metallurgical processes will be able to have a 0% levy
rate using an exemption used elsewhere in Europe under the EU Energy Taxation Directive. This
was announced by the Chancellor in the 2013 budget.
22
HM Treasury, 2010
22
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
4.7
CRC Energy Efficiency Scheme
The CRC Energy Efficiency Scheme (formerly the Carbon Reduction Commitment) is a mandatory
carbon emissions reporting and pricing scheme to cover large energy users in the UK (those using
more than 6,000MWh per year of electricity) that are not otherwise covered by Climate Change
Agreements or the EU Emissions Trading Scheme.
Participants in the CRC need to measure and report their electricity and gas related carbon
emissions annually following a specific set of measurement rules, and are required to buy
allowances from the Government each year to cover their reported emissions. The price of the
allowances was set at £12 per tonne of CO2 for the 2011/12 reporting year.
The CRC was converted to a tax in Budget 2011, raising some £950m a year.
4.8
Levy Control Framework
In 2011, in recognition of the need to monitor and control the considerable cost of energy
investments funded by households and businesses through their electricity bills, the Government
introduced the Levy Control Framework (LCF). The LCF sets a ceiling on the overall cost of DECC’s
levy-funded policies, including the Renewables Obligation (RO), small scale Feed in Tariffs (FiTs),
and Contracts for Difference (CfDs). The LCF spending cap was set at £2 billion in 2011-12 and is
set to rise to £7.6 billion in 2020-21 (in 2011-12 prices).
In future, the Capacity Market will also be included in the LCF. However, expenditure will not begin
until 2018, and when there is greater certainty on the size of the levy it will be given its own,
separate budget, which we assume will be additional to the above.
It is important to note that the LCF does not include levies applied to business, other than through
electricity bills. As such, it does not encompass the costs of the EU ETS, CPS, CCL and CRC Energy
Efficiency Scheme.
4.9
Carbon Leakage
Carbon Leakage describes the situation where for reasons of cost related to climate policies,
businesses offshore jobs and production to other countries which have lesser or no constraints on
greenhouse gas emissions. This can lead to an increase in total global emissions, if manufacturing
processes are less efficient and there are increases in transportation of goods.
This has been recognised by the EU in relation to the EU ETS for those industry sectors deemed
most at risk because they are unable to pass on EU ETS-related cost increases to their customers
without significant loss of market share.
The EU ETS introduced two mechanisms to mitigate the risk of carbon leakage:

Sectors deemed to be at significant risk of carbon leakage receive 100% free allocation of
allowances up to the sector’s benchmark (see Section 4.2); and

Member States are allowed to compensate sectors at significant risk of carbon leakage,
provided schemes are designed within a framework set by the European Commission.
According to the ETS Directive (Article 10a), a sector or sub-sector is deemed to be exposed to a
significant risk of carbon leakage if:

The extent to which the sum of direct and indirect additional costs induced by the
implementation of the directive would lead to an increase of production cost, calculated as
a proportion of the Gross Value Added, of at least 5%; and

The trade intensity (imports and exports) of the sector with countries outside the EU is
above 10%.
And also if:

The sum of direct and indirect additional costs is at least 30%; or
23
Walking the carbon tightrope: energy intensive industries in a carbon constrained world

The non-EU trade intensity is above 30%.
The sectors and sub-sectors which are deemed to be exposed to a significant risk of carbon
leakage figure in an official list, established by the European Commission after agreement by the
Member States and the European Parliament. The EU ETS Directive allows for a review of sectors
at risk every five years, with the possibility of adding sectors to the list on annual, ad hoc basis.
The first carbon leakage list was adopted by the Commission at the end of 2009 and amended in
2011 and 201223. The next substantive review of sectors will conclude in 2014.
In compliance with the second EU mechanism to address carbon leakage, the UK government is
currently developing support packages for those UK industries impacted by both the EU ETS and
EMR. These are described in Section 4.10 below.
The TUC is concerned that the definition of sectors at risk may be too narrow, in particular given
differences within sectors and sub-sectors across the EU. There is also concern that the existing
and proposed compensation measures are inadequate, in particular given the uncertainty and risk
introduced by energy and environmental policy into long-term capital investment decision making
in the UK. These issues are explored in the Case Studies in Sections 6 to 9.
4.10 UK government support for heavy energy users
Government policies aimed at reducing carbon emissions rely both on enhancing industrial energy
efficiency and pricing carbon emissions. In practice, this approach risks reducing the capacity of
industry to invest, and if applied unilaterally, distorts international competition, causes carbon
leakage and compromises the sustainability of UK businesses.
In response to representations from industry and trade unions, in the Autumn Statement in 2011,
the Chancellor announced the government’s intention to implement measures to reduce the impact
of policies on the cost of electricity for the most electricity-intensive industries. A commitment of
£250 million was given for the period 2013-2015 to offset the impact of rising electricity prices,
including:



Up to £100 million in compensation for impacts from the Carbon Price Floor pass-through.
£110 million compensation for indirect impacts of the EU ETS on electricity prices, in line
with European Commission state aid guidelines.
£40 million uplift on relief from the Climate Change Levy (from 65% to 90%) from April
2013.
In Budget 2013, this package was boosted by a further £150 and extended to 2016.
In October 2012, DECC and BIS launched a consultation into their proposals for the eligibility and
design of two energy intensive industries compensation schemes to counteract the impact on
electricity prices of both the EU ETS and Carbon Floor Price. The consultation closed in December
2012, and following state aid clearance, the government’s response and the design of the
compensation scheme for the EU ETS were published in May 2013 (see Section 4.10.1 below).
Details for the Carbon Price Floor compensation scheme, which remains subject to state aid
approval from the European Commission, have yet to be published.
In November 2012, further exemptions were announced to offset the additional costs arising under
Electricity Market Reform. Specifically, the Government announced its intention to exempt energy
intensive industries from the full costs of Contracts for Difference, subject to consultation and state
aid approval. The aim is to bring this exemption into force at the same time that EMR is
implemented. Although the value of these exemptions has yet to be specified, the Committee on
Climate Change estimates that they will amount to around £350 million a year for electricityintensive industries in 2020.
23
http://ec.europa.eu/clima/policies/ets/cap/leakage/index_en.htm
24
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
4.10.1 Compensation for the indirect costs of EU ETS
The European Commission has provided framework guidance to European Member States, setting
out which sectors and sub-sectors are eligible for compensation for the indirect costs of EU ETS24.
The UK government has applied these criteria to its compensation package. Consultations have
taken place with unions and industry through the government’s Energy Intensive Industries Task
Group.
Within eligible sectors, businesses will need to demonstrate that their indirect carbon cost (the
combined cost of EU ETS and CPS in 2020) will amount to 5% or more of their Gross Value Added
(GVA). Following the Commission guidelines, aid intensity must not exceed 80% of the eligible cost
increase in 2013, 2014 and 2015. In addition, the UK Government has set an overall budget limit
for the scheme. If there is a significant risk of budget overspend, the level of aid intensity may be
reduced below these EU guideline figures.
Up to December 2013, the ETS compensation scheme had paid out £18 million to 29 companies in
the energy intensive industries sector including Tata Steel, Celsa Steel and chemical firm Ineos
Chlor Vinyls, in the energy intensive industries sector.25
4.10.2 Compensation for the costs of CPF
The Carbon Price Floor (carbon tax) will raise £600m in 2013-14, rising to £1.2bn by 2015 and
beyond. Details of the compensation scheme, which remains subject to state aid approval from the
European Commission, have yet to be published. However in the consultation process, the
government proposed adopting the same criteria for determining eligibility as used for the EU ETS
compensation scheme. The Government has indicated that it might extend eligibility to sectors not
on the EU approved list, provided that companies are able to provide ‘firm evidence’ that the EU
ETS and CPF-related costs amount to 5% or more of their GVA, and that their products are
‘significantly traded within or beyond Europe or that imports would become more economically
viable as a result of increased carbon costs’. The approvals on this extended list would have to be
cleared with the European Commission as consistent with State Aid.
4.10.3 Compensation for the costs of CfDs
A consultation into the eligibility for exemption from the pass-through costs of CfDs closed in
August 2013. The government’s response to this consultation and the design of the CfD
compensation scheme has yet to be published. However, the Government has proposed using the
same eligibility criteria as those proposed for the EU ETS and CPF compensation schemes. As such,
eligible businesses would need to operate in specified sectors and be able to demonstrate that
carbon costs will amount to 5% of GVA.
In order to comply with EU rules on state aid, any exemption would also have to involve an energy
efficiency benchmark, require all beneficiaries to have signed Climate Change Agreements or pay
at least 20% of the costs they are being exempted from. The Government prefers the latter option
since it would have fewer administrative costs than an energy efficiency benchmark, and most
energy intensive companies have already entered into Climate Change Agreements in order to
benefit from an exemption under the climate change levy. Its preference would therefore be to
exempt eligible industries from 80% of the costs of CfDs, although it does put forward an option
for a lesser level of exemption for some companies. All options would see other consumers pay
more to cover the redistributed costs of the exemption.
The consultation also considers options that would exempt a wider range of businesses than those
eligible for compensation under the EU ETS compliance scheme. One option it suggests is to
extend the "5% test" to include CfD costs, as well as the costs of complying with the EU ETS and
Carbon Price Support mechanism. It also proposes extending the partial exemption to more
'medium electricity-intensive' companies which are not covered by EU ETS compensation support,
24
http://ec.europa.eu/clima/policies/ets/cap/leakage/index_en.htm
Hansard December 2013:
http://www.publications.parliament.uk/pa/cm201314/cmhansrd/cm131204/halltext/131204h0001.htm
25
25
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
a move which, the consultation claims, would "deal with the potential of a 'cliff edge' to a degree".
Another suggestion contained in the consultation is the option of 'tapering' relief, which would give
a wider range of industries varying rates of exemption relative to their costs.
However, according to the consultation, both alternatives carry more of a risk of "compensating
companies for their costs without affecting their behaviour/investment considerations" compared
with the Government's preferred option. A tapering relief may also mean more administrative
complexity and make EU state aid approval less likely.
26
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
5
5.1
Steel sector case study
Introduction
The steel case study examines the impact of policies on the competitiveness of Celsa UK relative to
its counterparts within the Celsa Group. Celsa UK, an electric arc furnace steelmaker, is the largest
producer of steel reinforcement in the UK. It is part of the Celsa Group, Europe’s largest producer
of long steel products with operations also in Spain, Poland, France and Norway.
There are two primary processes used in the production of steel: basic oxygen steelmaking (BOS)
in which iron ore, carbon (coke) and limestone are used to produce iron which is subsequently
refined, strengthened and moulded to create steel; and electric arc furnace (EAF) steelmaking in
which scrap steel is recycled into new steel.
The EAF process is far less resource intensive and more energy efficient than the BOS process (see
Figure 4). It consumes only one third of the energy and releases only one sixth of the CO2
emissions of basic oxygen steelmaking.
Figure 4: Process materials consumption in BOS and EAF processes
In the UK market, the volumes of virgin steel produced from blast furnaces and recycled steel
sourced from scrap metal are approximately the same, underscoring the significance of recycled
steel. While being highly energy efficient in comparative terms, the EAF process is nevertheless
electro-intensive and so highly sensitive to electricity price.
The world’s steel industry is dominated by global players such as ArcelorMittal (Luxembourg),
Nippon Steel & Sumitomo Metal (Japan), Hebei Iron and Steel (China) and Tata of India (formerly
Corus in the UK).
In the UK there are three integrated BOS sites at Scunthorpe and Port Talbot (Tata Steel), and
Teesside (SSI). The Teesside site is currently mothballed, but its new owners are planning to
restart shortly following an investment programme.
The UK steel industry also has five EAF steelmaking sites which are located at Sheffield (Sheffield
Forgemasters and Outokumpu), Rotherham (Tata Steel), Cardiff (Celsa Steel) and Sheerness
(Thamesteel – currently in administration). There is a further mothballed furnace at Newport (Mir
Steel).
All steelmakers in the UK other than Sheffield Forgemasters are foreign owned and part of larger
steel groups. As such, they are subject to international competition within their parent companies
for operational and capital investment.
27
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Downstream of the steel production process, there are steel re-rolling businesses located mainly in
the West Midlands, South Wales, North East, Scunthorpe and Sheerness, and tube making in
Corby, the North East, West Midlands and South Wales. Wire and other cold drawing operations
are largely independent of the steelmakers and are generally located in Yorkshire, the West
Midlands and North Wales.
Approximately 20,000 people are employed in direct steel production with many more in
downstream operations, and the sector contributed £1.9 billion to the UK balance of trade in
201226.
World steel production is presently at the highest level ever recorded, largely driven by rapidly
increasing demand in China. At 1,510 million tonnes, output of crude steel in 2012 was 12%
higher than that achieved pre-recession in 2007 (Figure 5).
Figure 5: Global crude steel production 1997 – 2012
In contrast, in 2012 UK steel output fell to 9.8M tonnes, one of the lowest annual outputs since
1934. 2012 output was 32 % less than in 2007 (Figure 6). In part this reflects the general
economic downturn within Europe and the UK. However, it is also believed to reflect energy and
environmental policy which is adversely impacting upon UK steel producers relative to their
European and international counterparts.
26
http://www.eef.org.uk/uksteel/About-the-industry/Steel-facts/Output-UK.htm
28
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 6: UK crude steel production 1991 – 2012
This case study looks specifically at the impact of policies on the competitiveness of Celsa UK
relative to its counterparts within the Celsa Group. Celsa UK is the largest producer of steel
reinforcement in the UK. It is part of the Celsa Group, Europe’s largest producer of long steel
products with operations in Spain, Poland, France, Norway and the UK.
The energy prices paid by the largest energy intensive companies are generally not public domain.
However, Celsa has shared insights from their operations. These show that the Celsa UK plant is
one of the most energy and labour efficient in Europe. However, as a result of UK energy and
environmental policy, it also faces the highest electricity prices within the Celsa Group. This is
undermining the long-term prospects of this highly efficient, low carbon business.
The ultimate conclusions and recommendations arising from this case study complement those
from the other case studies and are reflected in Section 9 of this report.
5.2
Overview of Celsa UK
Celsa, later to become Celsa Group, was established in Spain in 1967. It started out as a small
reinforcing bar re-rolling mill, but has gradually grown to become a vertically integrated business
and Europe’s largest producer of long steel products. The group has total annual sales of over
€4,500m, some 6,000 employees, and an output of around nine million tonnes of steel per year.
There are eight companies in the Group. These operate seven EAF steel mills in Spain, Poland,
France, Norway and the UK (Cardiff), which consume over ten million tonnes of scrap every year.
Acquired in 2003, Celsa UK is the largest producer of steel reinforcement in the UK and one of the
largest producers of other long steel products. Celsa Group invested £90m in state of the art melt
shop facilities in Cardiff in 2006, making it one of the most efficient in the group. Celsa UK facilities
also include a rolling reinforcing products and wire rod facility, and a plant for rolling merchant bar
and light sections.
Celsa UK produces around 1.2M tonnes of finished products annually, mostly for the British and
Irish markets. The company supplies products for some of the largest civil engineering
infrastructure projects in the UK. It serves the construction sector with reinforcing bar and high
yield coil, mesh, wire rod and ‘merchant bars’ (angles, flats, rounds and channels).
Approximately 700 people are employed directly at the Cardiff melt shop, and a further 1,000 in
other parts of the UK. The company estimates that its UK operations generate a further 6,300 jobs
indirectly.27
5.3
Celsa UK, electricity prices and the competitiveness challenge
CELSA UK operates one of the most efficient EAF facilities in Europe. It emits 270 kg CO2/tonne of
steel produced (2012), against a benchmark of 285 kg CO2/tonne for the best 10% of EAF
steelmakers in Europe (Figure 7). The EAF process operated by Celsa UK in Cardiff is so energy
efficient it presents few opportunities for reducing carbon emissions or the company’s £50m
annual electricity bill.
Despite operating a world class, energy efficient facility, Celsa UK has incurred operating losses
over the period from 2008 to date. There is growing concern that one of the most efficient steel
plants in Celsa Group’s European portfolio is exposed to carbon leakage as a result of UK climate
change policies and tariffs.
27
Celsa UK
29
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 7: Celsa UK direct and indirect CO2 emissions
A key challenge in Celsa UK’s drive to remain competitive and improve net margins is the structure
of its cost base. Approximately 70% of the company’s costs and 100% of its products are
internationally traded commodities. Both scrap steel feedstock and final products offer little room
to negotiate on price. Of the remaining transformation costs, approximately a third, or £50m, is
accounted for by electricity costs. This leaves Celsa UK controlling no more than 20% of its cost
base, in the form of labour and other costs (Figure 8).
Figure 8: Breakdown of Celsa UK’s operating costs
While production levels have been maintained, labour costs have been reduced by over 25%
against a 2008 baseline (Figure 9). Wages have been either reduced or maintained and employee
numbers reduced such that Celsa UK now has amongst the lowest labour costs within the Celsa
Group on a Euro/tonne output basis (Figure 10). As the wider economy begins to pick up, Celsa UK
now faces recruitment, retention and skills challenges in a competitive labour market where
certain key skills are highly sought after. It is becoming increasingly difficult to afford the market
price for these skills, given the lack of flexibility within the company’s cost structure.
30
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 9: Labour and electricity cost trends 2008 - 2013
Figure 10: Celsa UK labour costs benchmarked against Celsa Group
At the same time, energy costs have continued to rise in the UK, ahead of the rest of Europe.
Despite leading within Europe in terms of energy efficiency, Celsa UK faces the highest energy
costs within the group on a Euro/tonne output basis (Figure 11).
Figure 11: Celsa UK energy costs benchmarked against Celsa Group
31
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
The cost of energy for very large EII users is not generally transparent. Celsa have shared their
view on European prices based on their experience (Table 2). In their estimate, electricity prices
faced by the largest EIIs in the UK will be twice that of equivalent operations in Germany in 2014.
Furthermore, the planned policy mechanisms are anticipated to increase unit energy costs by 60%
over 2010 prices by 2020, although there is uncertainty about the scale and duration of support
measures (Table 3).
Table 2: Celsa estimation of 2014 electricity costs for energy intensive industries in
selected countries in the European Economic Area28
2013 Position
Renewables obligation currently
Feed-in tariff
EU-ETS cost pass through from generators
Carbon Price Floor additional pass through
Increase over 2010 prices
2020 Position
Renewables obligation
Feed-in tariff
EU-ETS cost pass through from generators
Carbon Price Floor additional pass through
Increase over 2010 prices
2030 Position
Assumed in line with DECC estimate
£8.66/MWh
£2.12/MWh
£0/MWh
£2.69/MWh
£8.6M ≡ 24.8 % increase
£10.00/MWh
£3.00/MWh
£19/MWh
£6.38/MWh
£21M ≡ 60 % increase
TBC
Table 3: Direct and Indirect Energy Tariff Costs
1
Renewable energy support schemes
Availability and utilisation revenues comprised (up to €400/MWh in Germany)
3
85 % x 0.76 teCO2 /MWh x €5/te CO2 (€500M in Germany and £125M in the UK from 2013 on
4
€1 = £0.8109
5
ARENH (historical nuclear energy) is considered in this table (tariff accepted by the EU). Alternatively, there is a lower
regulated tariff to expire end 2015 (Tariff Vert C – EIP)28
6
In France, ARENH regulated price has been considered (€42/MWh) minus back-selling surplus estimated at €1/MWh)
7
Virtual imports for 2010 – 2015 were based on German (no direct connection) and French prices. An allocation of 60 % has
been taken into account and a payment of €4.5/MWh for Terna’s operations: 60 % @ €40/MWh (Germany/France) + 40 %
@ €65/MWh (Italy)
2
32
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
5.4
Conclusions
Mr Tajani, the European Industry Commissioner, recently warned that Europe’s energy and
environmental policies risked undermining industrial competitiveness. He told The Daily Telegraph
during the Ambrosetti forum of global policy-makers at Lake Como that ‘we face a systemic
industrial massacre’ as America's shale revolution cuts US natural gas prices by 80%. He went on
to say that ‘I am in favour of a green agenda, but we can't sacrifice Europe's industry for climate
goals that are not realistic, and are not being enforced worldwide’29. The Celsa UK experience
suggests that this view can be amplified in relation to the UK relative to the rest of Europe too.
Celsa UK has been operating at a loss for some time, despite significant efforts to improve process
efficiencies and reduce costs. Celsa UK operates one of Europe’s most modern and efficient steel
production facilities. It invested £90m in 2006 in a new electric arc furnace which achieves worldclass emissions and production standards. Carbon emissions associated with the UK facility are not
only lower than blast furnace steel producers, but also other electric arc furnace facilities employed
in Celsa Group’s production portfolio.
Celsa UK has also driven down other operating costs in recent years to reduce overheads and
improve margins. Labour costs are now among the lowest within Celsa Group’s European business.
The company has little control over recycled steel costs because scrap metal is a commodity which
is traded in a global market. The reasons for Celsa UK’s poor commercial performance are
attributable mainly to wholesale electricity prices which are among the highest in Europe, and
considerably higher than Celsa’s other sites operating the same process. Planned unilateral UK
climate changes policies and tariffs, such as CPF and CfD are expected to exacerbate this situation.
This case study shows that UK energy and environmental policy is adding significant cost to UK
steel manufacture relative to both EU counterparts and international competition. This is distorting
the economics of supply against UK companies and is encouraging carbon leakage.
29
http://www.telegraph.co.uk/finance/financialcrisis/10295045/Brussels-fears-European-industrial-massacre-sparked-byenergy-costs.html
33
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
6
Heavy clay ceramics sector case study
6.1
Introduction
The ceramics sector is a cornerstone of the UK construction industry, with the ‘heavy clay’ subsector producing facing bricks, engineering bricks, pavers, clay roof tiles and clay drainage pipes
for use in housing, urban development and infrastructure projects. The sector is highly energy
intensive, accounting for approximately 4000 GWh of gas consumption and 600 GWh30 of
electricity consumption annually. Many UK-based heavy clay businesses are part of multinational
companies, characterised by headquarters located in other parts of the European Union and
multiple sites producing similar product ranges.
Our case studies include:

Ibstock, the UK’s largest brick producer, with a company history dating back to the late
19th Century. It employs just under 1,500 people and produces a broad range of heavy
ceramic products – primarily facing bricks and special shapes - from 19 UK sites.

Marley Eternit, part of the Etex Group, with 105 companies operating 123 factories in 45
countries around the world. The Group is headquartered in Belgium. In the UK, Marley
Eternit produces clay roof tiles at Keele, Staffordshire.
While the ceramics sector as a whole generally uses more gas than electricity (all heavy clay kilns
are gas-fired, for example) some ceramics companies are among the most electro-intensive in the
UK. Refractory and technical ceramics manufacturers operate electric arc and induction furnaces at
temperatures above 2,000oC. Several of these highly electro-intensive manufacturers have already
relocated overseas, with electricity costs being cited as one of the reasons for closing down UKbased operations. Carbon leakage is therefore already occurring within the ceramics sector, albeit
in very specific product areas.
Heavy clay producers have been severely affected by the economic downturn since 2008, and
many plants have been either permanently closed or mothballed. There were 93 operational heavy
clay sites in the UK in 2008; at end of 2013 only 63 remained with three sites mothballed and 25
permanently closed.31
In the last year there has been an upturn in the housing market, driven in part by increasing
market confidence and the Government’s Help to Buy scheme. Although heavy clay manufacturers
have responded promptly to increases in demand for bricks and clay tile products from house
builders, at present there is still under-capacity in the market and output remains at just 60-70%
of pre-recession volumes. This under-capacity is being redressed by sourcing more materials from
overseas markets, not only from other parts of the EU but also new geographies such as Turkey
and the Indian sub-continent, and there is clear evidence that some of these competitors
established a foothold in the UK market during the recession.
The ceramics sector operates to long investment cycles. As a result, highly uncompetitive UK
energy prices (for electricity, sometimes twice that of European competitors) and UK-specific
escalator tariffs on electricity bills, gas supply security and price volatility risks, accompanied by
support mechanisms with time horizons which extend no further than the current Treasury
spending review period, pose serious risks to business planning processes. In addition a more
flexible regulatory and R&D funding environment in other EU countries, such as the Netherlands,
Germany and France, are driving strategic investment decisions offshore.
At a time when the heavy ceramics sector should be responding favourably to a recovering UK
housing market, direct and indirect energy tax burdens and below-capacity production, coupled
with increasing trade intensity, are giving rise to the threat of carbon leakage, with the potential
for this sub-sector to start following its electro-intensive counterparts out of the UK.
30
31
BCC CCA database (2010-11)
BCC Climate Change Agreement sites 2008-2013
34
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
6.2
Trends in European and UK markets
The ceramics sector makes a positive contribution to the trade balance of the EU. Cerame-Unie
estimates32 that around 25% of EU production is sold outside the EU with, for example, total
exports in 2011 of €7.2 bn and imports of just €3.5 bn. This trend is continuing with 2011 exports
increasing by 7.3% and imports decreasing by 5.9% compared to 2010. Cerame-Unie nevertheless
highlights increasing trade intensity as an area of concern in its 2050 Roadmap. This is evidenced
by the status of the ceramics sector within the EU ETS.
Having originally been omitted from carbon leakage status during round 1 of the EU ETS, there is
now increasing consensus that brick and clay tile companies are indeed exposed to carbon
leakage. Following the 2010 EU ETS review, and using a ‘qualitative assessment’, the NACE code
sector (2640) ‘Manufacture of bricks, tiles and constructions products, in baked clay’ formally
qualified as ‘exposed to significant risk of carbon leakage’, a decision which was ratified in
November 2011 by the European Commission33. This decision made reference to, among other
things, challenging market conditions, ‘in particular increasing trend in imports from low cost
manufacturing countries, increased international competitive pressure, …and only modest profit
margins for the years evaluated compared to the additional CO2 cost, which limit the capacity of
installations to invest and reduce emissions.’
As outlined in Section 4.2, businesses which are exposed to significant risk of carbon leakage
receive approximately 95% of EU benchmark allowances for free. For those not deemed at risk of
carbon leakage, this figure is 82%, falling to 25% in 2020. Retention of ‘carbon leakage’ status in
the 2014 review for the period 2015-2019 is therefore critical to the heavy clay sector as its loss
would incur heavy penalties.
At a UK level, domestic demand for heavy clay products has been met by domestic production,
and trade intensity has historically been relatively low. However, Figure 12 and Figure 1334
indicate that, over the three year period 2011-2013, the level of clay tile and brick imports rose
significantly, despite the housing market only picking up towards the end of that period. Even
during the recession, therefore, some of the domestic demand for bricks and tiles was being met
by imports at the same time as UK plants were closing or being mothballed.
32
Cerame-Unie, Brussels (Undated) Paving the way to 2050 the ceramic industry roadmap
http://www.cerameunie.eu/en/news/european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future
accessed January 2014
33
Commission Decision of 11 November 2011 amending Decisions 2010/2/EU and 2011/278/EU as regards the sectors and
subsectors which are deemed to be exposed to a significant risk of carbon leakage
34
https://www.uktradeinfo.com
35
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 12: Total imports of bricks by volume
Figure 13: Total imports of roof tiles by volume
The underlying trade data shows that brick imports reached more than 14% of total sales, whilst
tile imports rose by 53% between 2011 and 2012, and then a further 11% over the corresponding
period in 2013. Between January and October 2013, 38,813 tonnes of clay tiles were imported,
with a value of £10.7 m, although it is interesting to note that the value of imports did not rise as
significantly as the quantity of product, suggesting that pricing was being demand side driven.
The principal European countries driving carbon leakage from the UK include France, The
Netherlands and Germany, with Poland and Denmark also acting as significant exporters of clay
roof tiles to the UK. However, notably, in the context of carbon leakage beyond the EU, trade
routes from Turkey, China, India, Pakistan and even Sri Lanka and Vietnam appear to be getting
established for brick and or roof tile products.
6.3
Responding to recovery in the housing market and construction sector
Levels of house building across the UK increased gradually during 2013, with the private sector
leading the way and much of the demand driven by the Government’s Help to Buy scheme. The
NHBC reports35 that the number of homes built in the UK in 2013 (133,670) was the highest since
the start of the economic downturn, and a 28% increase on 2012. Significantly, the figures still fall
short by almost a factor of two on the number of new houses considered necessary to
accommodate an increasing population. Even in 2007, prior to the economic downturn, the annual
figure was just 200,000 homes, suggesting that considerable latent demand for new housing stock
will remain for some time.
The positive turnaround in construction and house building activity has given rise to unusual
market distortions. A recent industry survey36 conducted by the Construction Products Association,
(CPA) for example, highlights that:

Manufacturers are reporting a short-term supply problem caused by historically low stock
levels of building materials, particularly bricks and blocks.
35
Reported in the Daily Telegraph online 30 January 2014 http://www.telegraph.co.uk/property/propertynews/10608718/Newhomes-boom-helps-to-build-the-recovery.html accessed January 2014
36
Construction Products Association Qualitative Analysis of UK Construction Manufacturing Capacity 26 September 2013
36
Walking the carbon tightrope: energy intensive industries in a carbon constrained world

These short-term supply constraints are compensated for by the fact that there is sufficient
manufacturing capacity in the UK to cope with market expansion of all materials.

Capacity increases across the building products industry will need to be accompanied by
investment security in the supply chain.

Manufacturers will need to pass on costs to secure the margins required to justify
continued investment in UK production capacity.

Confidence in long-term investments will be dependent on the sustainability of demandside factors and market volumes, regulatory certainty, and energy security.
The CPA report suggests that, as house building starts to pick up pace, manufacturers have raised
production of bricks and other construction materials, whilst using imports as a temporary buffer.
Brick production in November 2013 was 27% higher than a year earlier according to the latest
statistics from the Department for Business,37 and major brick producers have worked over the
winter period for the first time in five years. At the same time, imports of bricks in Q3 of 2013
were 39% higher than a year earlier.38
It is clear that, in the longer term, a balance between sufficient production capacity and a
sustainable demand for bricks is needed to reduce reliance on imports and avoid the closures and
mothballing seen over the last five years.
6.4
The impacts of climate change tariffs and support mechanisms
As a result of their energy intensive nature, heavy clay ceramics companies are subject to
substantial direct and indirect costs associated with both EU and UK climate change policies and
electricity market tariffs. More than 1,000 ceramic installations are subject to the EU ETS,
representing >10% of the number of industrial installations covered by the scheme, but only 0.5%
of the scheme’s CO2 emissions. This is because 75% of ETS installations in Cerame-Unie’s
membership are classed as ‘small emitters’ (i.e. production >75 te/day and emissions <25,000 te
CO2/year)39. Since 2013, there has been an EU ETS small emitter scheme in the UK, to help
minimise administrative costs.
A number of the tariffs paid by British ceramics producers, such as CCL, CfD and CPF apply only to
the UK. In some heavy clay companies fixed, pass through and carbon-related energy tariffs
already account for around 30% of operating costs, and in some cases this proportion has doubled
since 2006. By 2020 it is anticipated that these costs may account for approximately 55% of total
OPEX. As seen in the steel case study (see Section 5), market distortions are arising between
British producers and their overseas counterparts operating within the same parent company,
since opportunities to drive down energy consumption costs are constrained by the existing use of
best in class technologies at many facilities.
6.4.1
EU ETS
The allocation of carbon under EU ETS is based upon industry benchmarks, with the benchmark for
bricks being considered highly ambitious. CO2 emissions arise, not only from energy consumption,
but also from embedded mineral carbon in the clay feedstock which is released as process
emissions. The carbon content of natural clays is highly variable around the UK. In fact, the
content in the local Etruria marl serving the Ibstock and Marley sites in this study is very low, but
even the most energy efficient heavy clay factory will give rise to higher, unavoidable process CO2
emissions if the mineral carbon content in the feedstock is high. (This provides an interesting
comparison with the cement and lime sectors profiled in Section 6, where process-related CO2
emissions are highly significant but nevertheless generally consistent amongst different producers
in the EU.)
37
www.theguardian.com/business/2014/jan/10/brick-shortage-threatens-construction-sector-recovery accessed January 2014
The Guardian (2014) op. cit.
39
Ceram-Unie, Brussels (Undated) Paving the way to 2050 the ceramic industry roadmap
http://www.cerameunie.eu/en/news/european-ceramic-industry-launches-2050-roadmap-paving-the-way-to-a-better-future
accessed January 2014
38
37
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
There is no means to abate the carbon content occurring naturally in clays. The benchmark in the
ETS Directive is based on the average of the top 10% of the lowest emissions processes in overall
carbon emissions terms. However, closer inspection of
Figure 14, derived from studies40 by the European Bricks and Tiles Federation (TBE), reveals that
the natural geographical variations in clay types does indeed give rise to variations in overall
specific CO2 emission rates, and in turn influences the relative ranking of ceramics producers,
inevitably creating market distortions. In some cases the least fuel-efficient enterprises have
favourable specific emissions rates because of their low levels of process CO2.
Figure 14: Specific process- and energy-related CO2 emissions rates for facing bricks
The UK EU ETS support mechanism, completely bypasses the ceramics sector, since the sector is
generally not electro-intensive as defined by the EU41: electro-intensive installations account for
about 40% of the electricity used in the ceramics sector, and consume about 10% of the total
energy used, and comprise less than 10 % of the installations42. Although some ceramics firms are
the most electro-intensive in Europe, about 85% of energy demand across the ceramics sector as
a whole is supplied by gas. These highly vulnerable installations are therefore denied access to a
key part of the EU ETS and Carbon Price Floor support package (see Section 4.4.3).
6.4.2
UK support mechanisms
CCL and CCA
The Climate Change Levy (CCL) is an environmental tax on energy supplies to industry which was
introduced in 2001. As described in Section 4.10, the Chancellor announced in last year’s Budget
(2013) that the Treasury proposes to introduce 100% relief from the costs of the Climate Change
Levy from April 2014 for mineralogical and metallurgical processes. This Exemption was applied
under the EU Energy Taxation Directive and is in force in a number of other Member States. The
BCC considers that the tax relief will not be significant in proportional terms, saving only about 2%
of energy costs for its members, but acknowledged the importance of the concession in terms of
Government recognition of the cumulative burden of electricity taxes faced by the sector, and the
need for a more level playing field with the rest of Europe.
40
TBE 2010 benchmarking exercise
annex II of the ETS State Aid Guidelines (Commission Communication 2012/C 158/04 of 5.6.2012) http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2012:158:0004:0022:EN:PDF
42
BCC, CCA data for 2012
41
38
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Electricity Market Reform: CfD and CPF
UK Government proposals to provide Contract for Difference support mechanisms to ceramics
sector businesses are very limited in scope (see Sections 4.10.2 and 4.10.3). With regards to CPF
compensation, the Government is currently pursuing a two stage approach, with those companies
on the annex II ‘EU ETS electro-intensive sectors list’ benefitting first, and other sectors later if at
all. As a result, the UK Government is taking the case of a handful of UK electro-intensive ceramic
manufacturers to the European Commission to apply for Carbon Price Floor compensation, but
none of these are in the heavy clay sector.
At a European level, the Commission has recently released a proposal for consultation regarding
state aid43. A key eligibility criterion in the proposal (which references the EU ETS Annex 2 indirect
compensation list) is that “the costs of funding renewable energy support lead to a substantial
increase in production costs, calculated as a proportion of the gross value added amounting to at
least 5%. The ceramics industry believes that GVA is completely inappropriate as a denominator
since electricity taxes are effectively being measured as a percentage of the wages bill. In
recession, and for barely profitable firms, this discriminates very heavily against companies and
sectors that are more labour-intensive.
Given the emerging guidelines, there are thus major concerns over whether the most electrointensive UK installations in ceramics, clay, minerals, glass etc. will receive any compensation at
all under the proposed schemes for CfD and CPF, and the outlook for the heavy clay sector is even
more uncertain. Figure 15 summarises the current status of support measures for ceramics
businesses in the UK, and indicates the market distortions being introduced, not only within the
sector, but across the energy intensive industries.
Ceramics Subsector
EU ETS indirect
compensation on
electricity
Electro-intensive
ceramics
X
Heavy clay and
rest of ceramics
sector
X
X
Carbon
Price
Floor
EMR /
CFD
X
Renewables
Obligation
Small
Scale
FITs
CCL*
@
@
I
@
@
I
Sector excluded
Presently highly unlikely due to exclusion from EU ETS indirect compensation list and challenges
with draft State Aid Guidelines – but industry welcomes that UK Government taking case forward
I
Sector included
@
No proposals to compensate any sector
Sector contributing to other EII sectors’ exemptions
*CCL
Not a component of the package of measures for EIIs
Figure 15: Support packages for EU and UK Climate Change and Energy Taxes
6.5
6.5.1
Specific challenges facing the UK heavy clay sub-sector – two case studies
Ibstock
Ibstock is the UK’s largest brick producer, with a company history dating back to the late 19th
Century. It employs just under 1,500 people and produces a broad range of heavy ceramic
products – primarily facing bricks and special shapes - from 19 UK sites.
Increasingly, more innovative products have been developed for the construction market to reflect
modern day building requirements. One example is an external wall insulation system clad with
43
http://ec.europa.eu/competition/consultations/2013_state_aid_environment/draft_guidelines_en.pdf
39
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
clay products used for the renovation and upgrading of existing domestic and commercial building
stock.
Ibstock’s multinational parent company, CRH Group, is headquartered in Ireland. Ibstock Brick’s
Chesterton site, one of the two heavy clay businesses referred to in this case study, opened a new
facility in 2013. It features the latest kiln and brick-making technology, and is among the most
energy-efficient of its type in the world. Ibstock’s £20M investment represents, along with Marley
Eternit’s investment at Keele (see below) are the largest capital expenditure in the UK’s ceramic
industry for many years. The Chesterton site has the capacity to produce 70 million bricks per
year.
Production at all of Ibstock’s factories has been severely affected by the economic downturn and
the concomitant decline in the construction sector. In 2007 2.5 billion bricks were produced by UK
brick manufacturers and this virtually halved to 1.3 billion in 2010. By 2013 the market had risen
but only back to 1.6 billion44. This resulted in 25 factories permanently closed – almost all brick
producers – out of the 93 UK heavy clay factories that had been operational in early 2008.
From an energy consumption (and carbon emissions perspective), the low production levels have
impacted on specific energy consumption and costs for the company. Specific energy consumption
varies considerably according to production rates – heavy clay producers must continue to operate
continuous tunnel kilns at sub-optimal efficiency levels to retain sufficient capacity for when
market conditions recover, and avoid costly damage to the refractory components in the kilns.
Energy costs at Ibstock during this period have virtually doubled due to a combination of
commodity cost rises and significant increases in climate related taxes and efficiency schemes. The
company anticipates that the costs associated with climate related taxes and efficiency schemes
will triple over the next seven years.
6.5.2
Marley Eternit
Marley Eternit is part of the Etex Group, with 105 companies operating 123 factories in 45
countries around the world. The Group is headquartered in Belgium and has approximately 18,000
employees (9,900 in Europe) and €3.168 billion in revenue.
In the UK, Marley Eternit produces clay roof tiles at Keele in Staffordshire. The most recent K3
production unit on the site is a modern (commissioned in 2006) and highly energy efficient facility.
At present, however, the facility is running at only 60% of potential capacity, and as shown in
Figure 16, annual production levels are variable and have not recovered to pre-recession levels.
Investment in this new plant resulted in closure of a production facility in Cannock.
Figure 16 Annual production levels at Marley Eternit, Keele
https://www.gov.uk/government/collections/building-materials-and-components-monthlystatistics-2012 (2007 data available in 2012 excel spreadsheet)
44
40
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Historically, Marley’s energy cost ratios between gas and electricity were approximately 2:1,
reflecting the energy intensity of the gas-fired kiln. Specific energy consumption is more
controllable than that reported by Ibstock, mainly due to the greater flexibility afforded by the five
tunnel kilns, and gas consumption has declined from 1,800 kWh/tonne to 1,400 kWh/tonne as a
result of the investment in the new plant and improved energy efficiency. However, electricity
costs are rising, not only as a result of direct and indirect taxes and tariffs and increasing
wholesale prices, but also as a consequence of fuel switching from gas to electricity, driven by the
desire for greater plant efficiency and environmental performance. For example, the Keele K3
plant is highly automated along the production lines both prior to and following firing of the clay
products. Variable speed drives, kiln motors and conveyor motors all serve to drive down costs but
are nevertheless still significant electricity consumers.
As with Ibstock, large capital investment decisions are taken by Marley’s parent company outside
the UK and new capital projects have increased the company’s roof tile production in competing
jurisdictions. For example, in 2012 a new clay roof tile factory was opened in Koscian, Poland, not
only to supply the domestic market, but also to export to other European countries. Trade
intensity is increasing in the UK, with tiles being imported from as far away as Turkey for the first
time in recent years.
6.5.3
Cost escalation and security of energy supply
The heavy ceramics sector is not generally considered to be electro-intensive, but electricity
supplies currently account for 30% of energy costs for both Ibstock and Marley. An underlying aim
of energy and environmental policy mechanisms is to encourage and incentivise energy intensive
sectors in their transition to a low carbon economy. An implicit assumption within this regime is
that businesses will invest in low carbon technologies because they will see a return on
investment, within acceptable payback periods, relative to both the costs of carbon taxes, and the
continuing use of older, more energy-intensive technologies. Figure 16 and Figure 17 illustrate,
however, that even following investment in state of the art facilities, energy price escalation over
time can skew returns on investment.
Figure 16: Marley energy costs as a proportion of total production costs
41
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 17: Energy price escalation and specific energy consumption at Marley
Looking in greater detail at how electricity bills might develop, and in particular the effects of ‘nonbaseload’ charges, Figure 19 illustrates how non-baseload charges (fixed, pass through and green
taxes) at Ibstock are rising from 25 % (2007 figures) to over 45% in 2013 to over 60 % (2020
estimate). Baseload charges include EU ETS indirect pass through charges in this example, but it
is notable that the baseload costs do not include provision for Contract for Difference, potential
extra charges for ESOS pilot pass through or charges likely to be incurred by likely extra measures
by National Grid to promote a demand side responses in winter.
Figure 18: Increases in non-baseload charges at Ibstock as a % of total electricity bill
To compound uncompetitive electricity prices, UK heavy ceramics producers face potentially
significant security challenges for gas supplies. Although the gas price is currently steady, rules
42
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
governing procedures in the event of chronic shortage state that many manufacturers relying on
gas for production can have their supplies terminated at very short (four hours) notice. At the
moment, sites are exempted from shutdown only if the potential damage to factory equipment
from gas supply interruption is more than £50 million. All UK heavy clay businesses, including
Ibstock and Marley, fall below this threshold, but nevertheless face potentially serious damage to
their tunnel kilns should gas supplies be cut.
6.6
Conclusions
The European ceramics sector is now considered to be at risk of carbon leakage through market
distortions arising from trade barriers and unfavourable climate change and carbon taxation
policies. These EU-level business challenges are exacerbated in the UK by unilateral direct and
indirect energy costs, placing UK producers at a competitive disadvantage to European
counterparts.
The UK ceramics sector has very limited access to current government support mechanisms. The
heavy clay sub-sector will not receive any CPF relief (and therefore, by inference) through CfD
support mechanisms.
For those handful of highly electro intensive ceramics companies (for example in the technical
ceramics and refractories sectors) which may receive CPF (and CfD) compensation, the duration
and scope of the UK support package is an issue. For example, the compensation for CPF and EU
ETS indirect costs are only proposed at present for the current spending review period, whereas
the taxes will continue well beyond this. Investment cycles in the sector are far longer than
Treasury spending review periods and manufacturers therefore need to be able to plan on a long
term basis. Indeed, several of the highly electro-intensive factories have already relocated outside
the UK, some to Germany and France, with electricity costs being cited as a major influencing
factor.45
Energy efficiency measures are the most obvious way to reduce fuel emissions. However, the
operational life of a kiln can be over 30 years, and payback periods on major capital spend are not
commercially sustainable. It is not practicable to routinely upgrade kilns before the end of their
operational life and replace them with more energy-efficient models. Even when substantial new
investments have been made in new state of the art kilns and production facilities, as is the case
at Ibstock Brick and Marley Eternit, and where these facilities are using the lowest process
emissions clay in the UK, this has not been sufficient to overcome the market distortions arising
from energy costs and EU and unilateral UK tariffs.
Heavy clay producers have been severely affected by the economic downturn since 2008, and
many plants have either been permanently closed or mothballed. There has, however, been an
upturn in the housing market over the last year, driven partly by increasing market confidence and
the Government’s Help to Buy scheme. Although heavy clay manufacturers have responded
promptly to increases in demand for bricks and clay tile products from housebuilders, at present
there is still under-capacity in the market and output remains at just 60-70% of pre-recession
volumes. This under-capacity is being redressed by sourcing more materials from overseas
markets, not only from other parts of the EU but also new geographies such as Turkey and the
Indian sub-continent. For the first time in its history, and at a time when there are signs of
recovery from a deep recession in the construction industry, there are real indications that imports
of bricks and clay roof tiles have gained and may be continuing to gain ground rapidly in the UK
market.
The key to remaining competitive and keeping jobs in the UK is investment, but investment
decisions are being delayed and compromised. The UK is increasingly being viewed by overseas
owners as an unfavourable place to invest. There need to be real incentives to invest, based on
reliable, predictable and long-term tariff forecasts.
45
BCC pers. comm. December 2012, but also presented in written submissions to the EAC and the Chancellor
43
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
7
7.1
Mineral products sector case study
Executive summary
The mineral products industry is large and important to the UK economy. It accounts for over £4
billion of gross value added (GVA) each year and employs 70,000 people, with a further 2.5 million
people employed in consuming sectors46. Employment is geographically spread through every part
of the UK, including rural areas where the industry creates demand for skilled labour and trades.
Within the mineral products industry, cement and lime manufacturers are the most energy
intensive and the focus for this case study.
An unusual feature of the cement and lime sectors is that a high proportion of carbon dioxide
emissions are governed by the chemistry of the industrial processes involved. In the absence of
new technologies like carbon capture and storage, this limits the opportunities to reduce overall
carbon emissions. Nevertheless the UK cement industry has achieved reductions of 55% since
1990, largely through investment in efficient plant, industrial rationalisation, and the replacement
of fossil fuels with waste derived biomass fuels. The lime industry, in which 53% to 75% of
emissions are defined by the chemistry of the process, has delivered abatement of combustion
emissions by 15% since 2005.
Opportunities to drive further emissions abatement in cement and lime production are limited by
available technologies and require significant government intervention in support of technology
development and commercialisation. The Mineral Products Association (MPA) has defined
emissions reduction scenarios for the UK cement industry of between 62% and 81% relative to
1990; however an 81% reduction is dependent upon carbon capture and storage technology being
commercially available and deployed at scale. Both scenarios also require significant investment in
alternative waste derived fuels, including biomass, and low carbon clinker.
Both cement and lime sectors have been badly hit by the recent economic downturn. In 2012, for
example, total cement production in Europe fell by 40% when compared to pre-crisis levels, and
the return on capital employed is well below the cost of capital for the industry47. In common with
the steel and heavy clay ceramics sectors profiled in previous case studies, there are now concerns
that the viability of these sectors in the UK will be undermined by financial burdens arising from
evolving UK energy and environmental policy, over and above EU obligations. There is emerging
evidence of carbon leakage and significant loss of value from the cement and lime sectors, at the
very time that there are signs of a recovery in the UK construction industry.
Cement and lime sectors are both capital intensive, with long investment time horizons. Energy
policies not only have an impact on the day-to-day operational finances of these businesses, but
also influence capital investment decision making. Policy uncertainty creates risk, which in turn is
reflected in higher hurdle rates for investment.
This case study looks specifically at the impact of policies and proposed relief on the climate for
investment in mineral products sectors. It finds that, rather than encouraging a transition to low
carbon technologies, the uncertain policy framework, unilateral burdens on UK producers, and
unrealistically short timeframes for support packages, are having a corrosive impact on the
investment climate and long term viability of these businesses in the UK. In particular, they are
stifling innovation and making offshoring of new investment a more attractive proposition to multinational parent companies.
The ultimate conclusions and recommendations arising from this case study complement those
from the other case studies and are reflected in Section 9 of this report.
46
Mineral Products Association
http://www.4-traders.com/news/CEMBUREAU--calls-for-cement-sector-to-maintain-carbon-leakage-status--17434318/
accessed December 2013
47
44
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
7.2
The UK mineral products industry, energy use and emissions
The mineral products industry, comprising aggregates, asphalt, cement, precast concrete, readymixed concrete, mortar, dimension stone, silica sand and industrial and agricultural lime, is a key
enabling sector for the UK economy as a whole, and in particular for construction. It accounts for
over £4 billion of gross value added (GVA) each year and employs 70,000 people, with a further
2.5 million people employed in consuming sectors48.
Cement and lime are the most energy intensive mineral product sectors, and the focus for this
case study. In the cement sector, electricity costs equate to more than 24% of business GVA (in
real 2007 prices), and total energy costs for approximately 38%. In the lime sector, these
numbers are 15% and 72% respectively.
These industries have taken significant steps to reduce energy use and emissions. The UK cement
sector has replaced part of its traditional fuel sources with biomass and waste, with alternative
fuels accounting for approximately 40% of its fuel requirements in 2012. In addition, direct
emissions of CO2 have been reduced from 924 kg/tonne of cement in 1998 to 730 kg/tonne of
cement in 2012 and, since 1990, absolute emissions reductions of 55% have been achieved,
largely as a result of investment in more efficient plant, industry rationalisation, and replacing
fossil fuels with waste derived biomass fuels.
This achievement is all the more remarkable given that 60% of carbon emissions associated with
cement manufacturing arise from the chemistry of the process itself. That is, carbon dioxide is
released as a natural by-product from the chemical alteration of the limestone feedstock. In the
lime sector this value rises to 80%. It is important to note that these entirely unavoidable carbon
emissions contribute to the carbon footprint of the industry which in turn is used in the calculation
of, for example, obligations under the European Emissions Trading Scheme (EU ETS) and the
Climate Change Levy (CCL).
Consultations with the MPA suggest that opportunities to drive further emissions abatement in
cement and lime production are extremely limited without significant government intervention in
support of technology development and commercialisation. In 2009, the International Energy
Agency (IEA) and the WBCSD together developed a cement industry technology roadmap. It
outlines existing and potential technologies, and how they may help the industry halve CO2
emissions.49 Based on this, the MPA has defined emissions reduction scenarios for the UK of
between 62% and 81% by 2050 relative to 1990. An 81% reduction is, however, dependent upon
carbon capture and storage technology being commercially available to the cement industry and
deployed at scale. Both scenarios also require significant investment in alternative waste derived
fuels, including biomass fuels, and low carbon clinker.
7.3
Energy and environmental policies and their impact on operational costs
Both the cement and lime sectors have been badly hit by the recent economic downturn. In 2012,
for example, total cement production in Europe fell by 40% when compared to pre-crisis levels,
and the return on capital employed remains well below the cost of capital for the industry.50 In
common with the steel and ceramics sectors profiled in previous case studies, there are now
concerns that the viability of these sectors in the UK is being undermined by energy and
environmental policy which will result in carbon leakage and significant loss of value.
The MPA recently published its assessment of the cumulative impact of the energy and
environmental policy mechanisms, described in Section 4, on its members51. This showed that
these measures add costs equivalent to 15% of the GVA of the cement industry today. Costs are
likely to increase from a current €51m to more than €250m in 2020, equivalent to 73% of GVA, in
particular if EU ETS CO2 carbon leakage status is lost. See Figure 19 below.
48
Mineral Products Association
Cement technology roadmap 2009 carbon emissions reductions up to 2050; IEA
50
http://www.4-traders.com/news/CEMBUREAU--calls-for-cement-sector-to-maintain-carbon-leakage-status--17434318/
accessed December 2013
51
Minerals Products Association (Undated) The Cumulative Impact of Environmental and Planning related Taxation &
Regulation. A preliminary and indicative assessment from the Mineral Products sector.
49
45
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Cumulative Burden of Policies on Portland Cement Manufacture
Indirect
Cost
250,000,000
150,000,000
Direct Cost
Cost (€)
200,000,000
100,000,000
50,000,000
0
2013
2015
2020
Year
Electricity Market reform
Renewable Obligation
Small Scale Feed in Tariffs
Carbon Price Support tax on fossil fuel use in power generation
EU ETS CO2 in electricity
Taxation of energy products (amendment) directive
CCA Compliance Cost
Climate Change Levy (with CCA)
EU ETS CO2 if carbon leakage status is lost
Figure 19: Cumulative Burden of Policies on the UK Cement Sector
The equivalent figures for the lime sector are shown in Figure 20. The cumulative cost of energy
and environmental policy mechanisms are estimated to be €8.4m today, equivalent to 19% of
sector
GVA, and
are forecast
toon
rise
to approximately
€50m
inManufacture
2020, equivalent to 117% of GVA52.
Cumulative
Burden
of Policies
Quicklime
and Dolomitic
Lime
Indirect
Cost
50,000,000
45,000,000
40,000,000
30,000,000
Direct Cost
Cost (€)
35,000,000
25,000,000
20,000,000
15,000,000
10,000,000
5,000,000
0
2013
2015
Year
Electricity Market Reform
Renewable Obligation
Small Scale Feed in Tariffs
Carbon Price Support tax on fossil fuel use in power generation
EU ETS CO2 in electricity
Taxation of energy products (amendment) directive
CCA Compliance Cost
Climate Change Levy (with CCA)
EU ETS CO2 if carbon leakage status is lost
Figure 20: Cumulative Burden of Policies on the UK Lime Sector
52
2020
Mineral Products Association
46
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
A key issue for the cement and lime sectors is their vulnerability to carbon leakage and, as the UK
transitions to a low carbon economy, the competitiveness of UK manufacturing needs to be
maintained against countries which do not carry the same cost of carbon. The Commission 2030
package has included announcements to the effect that carbon leakage status will be retained but
it is not yet certain. The Commission has until the end of 2014 to finalise its position. Even if
cement and lime stay on the list, the risk appears again in 2019 when it is reviewed once more.
7.4
Proposed government support packages53
The indirect costs of the EU ETS are those costs faced by electricity generators and passed through
to their customers in electricity prices (see Section 4). In the cement sector in 2013, these costs
are estimated to be €11.6m, rising to €19.4m in 2020 in the UK, whilst the indirect cost of EU ETS
to the lime sector in 2013 is estimated at €1.1m rising to €1.9m in 2020.
However, as a consequence of the sector eligibility test being conducted at EU level, neither sector
eligible to receive compensation for the indirect costs of EU ETS. At UK level both sectors would be
eligible, indicating the very high impact of these indirect costs on UK-based companies.
The indirect cost of Carbon Price Support (CPS) to the cement sector is estimated at €4.3m in
2013, €8.4m in 2014 and continuing to rise steeply to €21.7m in 2020. The MPA has submitted
data to the Department of Business Innovation and Skills (BIS) showing that both sectors exceed
the 5% GVA cost impact threshold for sectors eligible to receive compensation for CPS. BIS
determined that the evidence submitted by the cement sector was sufficient to apply to the
European Commission for EU state aid approval for compensation. However, there is no certainty
that EU state aid approval will be granted.
If deemed eligible for CPS compensation, the cement sector will receive €0 compensation in 2013
(unless the rules are changed on backdating compensation) and at most €7.4m in 2014 depending
on whether the compensation scheme has to be tied to the requirements of compensation for
indirect EU ETS. These requirements could include reducing the compensation by an electricity
efficiency benchmark. The compensation is currently only available until the end of the current
spending review period i.e. until April 2015. Therefore it is possible that no compensation will be
received from 2015 onwards.
If the cement sector receives relief from the CPF then it should also be eligible for exemption from
costs arising from Contracts for Difference (CfD), with an estimated maximum value to cement of
€4.1m in 2014 and €8.2m annually from 2014 onwards if the full cost is compensated.
The indirect cost of EU ETS to the lime sector in 2013 is estimated at €1.1m rising to €1.9m in
2020. The indirect cost of CPS to the lime sector is estimated at €427K in 2013, €825K in 2014
and rising steeply to €2.1m in 2020. Similarly, if the lime sector is eligible for CPS financial support
it will receive €0 compensation in 2013 (unless the rules are changed on backdating
compensation) and €993K in 2014, with nothing guaranteed beyond April 2015.
Should the lime sector be eligible for CPS support then it should also be eligible for exemption
from the costs of CfD. This has an estimated maximum value to lime of €404K in 2014 and then
€809k from 2014 onwards if the full cost is compensated.
It should be noted that the focus of these support packages is directed primarily towards electricity
consumption. Both the cement and lime sectors are electro-intensive as well as energy intensive
due to the significant energy required to grind and move hard and heavy materials.
7.5
Mineral products sectors and carbon leakage
There is broad consensus that the cement and lime industries are particularly exposed to carbon
leakage, as indicated in Figure 21 below.
The cement industry qualified as a sector exposed to carbon leakage under the EU ETS risk review
undertaken in 2009. Industry analysis suggests that these risks have since increased54.
53
All numbers provided by the Mineral Products Association
47
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
Figure 21: Sub-sectors potentially exposed under unilateral CO2 pricing55
Cement manufacturing involves the production of clinker in high temperature kilns. This is then
ground with other minerals to produce the powder that we know as cement. Clinker and cement
are both subject to international competition with approximately 13% of British cement
consumption supplied by imports in 2012.
A study undertaken by the Boston Consulting Group for CEMBUREAU in 2008 examined the
sensitivity of clinker production to overseas imports, taking into account the effects of carbon
pricing and inland transport costs from the main UK ports. It found that 100% of clinker
production in the UK is at risk if the CO2 price rises to €24/tonne (see Figure 22).
Figure 22: Isolines of cement clinker production at risk for different CO2 prices56
The lime sector, which is exposed to greater trade intensity than the cement sector, is subject to
additional risks in its supply chain. The primary consuming sectors for lime include other energy
54
http://www.cembureau.eu/cement-industry-exposed-carbon-leakage-regardless-assessment-method-used-and-relevantproduct-level accessed December 2013
55
Climate Strategies (2008). Differentiation and Dynamics of the EU ETS: Industrial Competitiveness Impacts by J.C.
Hourcade, D. Demailly, K. Neuhoff and M. Sato
56
Assessment of the impact of the 2013-2020 ETS proposal on the European Cement Industry, Boston Consulting Group,
November 2008
48
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
intensive industries such as iron and steel, glass, paper, pharmaceutical and chemicals which are
themselves facing financial pressures from the regulatory and policy framework.
Any loss of UK manufacture to other jurisdictions will almost inevitably result in an increase in
emissions, given the increase in transport that would be associated with lime imports, and the fact
that there is little scope to reduce emissions from the manufacturing process itself.
7.6
Energy and environmental policies and their impact on investment
An underlying aim of energy and environmental policy mechanisms is to encourage and incentivise
energy intensive sectors in their transition to a low carbon economy. An implicit assumption within
this regime is that businesses will invest in low carbon technologies because they will see a return
on investment within acceptable payback periods relative to the direct and indirect costs of carbon
taxes and the continuing use of energy-intensive technologies.
There is however a dis-connect between the known short lifetime of policy and support
mechanisms and the long term investment periods of major capital projects. The cement and lime
sectors both comprise capital-intensive businesses with multi-decade investment cycles. Portland
cement kilns have a typical lifespan of 35-40 years and are generally sited near to quarries with
50-60 years-worth of limestone. Lime kilns are similarly long-lived. As an example, in 2004
Tarmac invested £110 million in a new kiln at its Tunstead site at Buxton which replaced a kiln that
was installed in 1965. Estimated costs for a second kiln at the Tunstead site are in the region of
£200m57.
Capital and energy intensive industries, such as cement and lime, need a stable legal and policy
framework and consistent support mechanisms upon which to make long-term, large scale capital
investment decisions. Evolving EU and UK energy and environmental policies create uncertainty
and risk, as shown in Figure 23, which in turn is reflected in higher hurdle rates for investment.
These uncertainties add to the risk faced by UK investors relative to their EU and international
counterparts, and are additive to the normal commercial and technical risk associated with a new
capital investment.
Any business considering investment in Europe today will face the following EU ETS policy-related
uncertainties and risks:




57
An increasing over-supply of ETS allowances and credits, combined with low market demand
following the global economic downturn, have prompted the EU to propose amendments to the
timetable governing the release of new allowances during Phase III of the ETS. In particular,
there are proposals to ‘back-load’, or delay, the scheduled auctioning of new allowances into
the Phase III market.
Back-loading will partly address the anticipated imbalance between supply and demand in the
Phase III market. It will not, however, be sufficient to recalibrate the estimated structural
surplus of 2 billion Phase II allowances which will continue to distort the market. Further Phase
III structural changes have been discussed, as has increasing the EU emissions reduction target
in 2020. In January 2014, the introduction of a Market Stability Reserve was announced from
2021 onwards in order to address this challenge in the longer term (see Section 4).
Any business considering investment in new or substantially expanded capacity faces further
risk related to the environmental permitting regime and the ETS New Entrants Reserve. The
latter point is highly significant because allowances under the New Entrants Reserve cannot be
applied for until a new plant is commissioned. If there are allowances left, the number received
is based on the first 90 days of operation. Under the current arrangements for new entrant
allowances, failure to achieve optimal operating capacity during the first few months of
commissioning, even if these problems are ultimately resolved a short time after the 90 day
threshold, will result in a lower allowance allocation. This could make the newest most carbon
efficient plant uncompetitive in the market.
The list of sectors eligible for carbon leakage status is under regular 5-year review and an
updated list will be published in 2014. The Commission announced in January 2014 that the
Derby County Council Planning application 2011
49
Walking the carbon tightrope: energy intensive industries in a carbon constrained world


carbon leakage review would be based on the same criteria (including a carbon price of €30)
that were previously used in the 2009 review. This makes it more likely that both cement and
lime will remain on the list of sectors vulnerable to carbon leakage but beyond 2020 there is no
guaranteed protection from carbon leakage.
New plant cannot rely on the decommissioning of old plant or industry rationalisation. Plants
are required to run at 50% of their activity level in order to receive 100% of their allowance
allocation. This promotes the continued use of less efficient plant, and there is no rule for
moving production to more efficient plant.
Beyond 2020 the political landscape is very uncertain; there could be major structural reforms
to the EU ETS in Phase IV and there is no sign of an international agreement which could level
the playing field with competitors outside the EU.
EU ETS
Concept
development
Design
UK-specific policy mechanisms
Impact of back-loading of EU ETS
allowances in Phase III
Impact of possible further structural
changes including accelerated
retirement of allowances
Review of carbon leakage list in 2014
and every 5 years thereafter
Install and
commission
Scale and availability of New Entrants
Reserve
Performance of plant during first 90
days of operation for EU ETS allowances
assessment
Eligibility for, and scale of EU ETS
indirect support
Potential increase in EU emissions
reduction target to 30% or 40% in 2020
Eligibility for, and scale of CPS support
Eligibility for, and scale of CfD support
Persistence of support packages beyond
2015
Scale of Capacity Mechanism costs
Eligibility for, and scale of Capacity
Mechanism support
Ongoing changes to policies in
renewables
Operate
Nature of EU ETS scheme in Phase IV
(post 2020)
Scale and persistence of CCL reduction
available to CCA members beyond 2023
Decommission
and dismantle
Disincentive for industry rationalisation
Figure 23: Policy uncertainly and risk faced by UK capital investment
UK cement and lime producers are further impacted by uncertainty surrounding the eligibility
criteria, scale and durability of UK-specific policies and support packages. For example:
Uncertainty and risk faced by UK investors as a result of energy and environmental policy mechanisms

The details of the Carbon Price Floor compensation scheme, which remains subject to state aid
approval from the European Commission, have yet to be published. However in the consultation
process, the government has proposed adopting the same criteria for determining eligibility as
used for the EU ETS compensation scheme. The Government has agreed to apply to the
Commission for state aid approval to extend eligibility to sectors not on the EU approved list. In
order to be included in this extended list, sectors and companies must provide ‘firm evidence’
that the EU ETS and CPS-related costs amount to 5% or more of their GVA, and that their
products are ‘significantly traded within or beyond Europe or that imports would become more
economically viable as a result of increased carbon costs’. These eligibility criteria are already
50
Walking the carbon tightrope: energy intensive industries in a carbon constrained world





giving rise to disagreements between producers and regulators, for example in relation to the
calculation of GVA, and there is no guarantee the Commission will grant state aid approval to
this extended list of sectors, which includes the cement sector.
Similarly, in relation to eligibility criteria for exemption from CfDs tariffs, the Government has
proposed using the same eligibility criteria as those proposed for the EU ETS and CPS
compensation schemes. As such, eligible businesses would need to operate in specified sectors
and be able to demonstrate that cost impact will amount to 5% of gross value added (GVA).
The impact of policy measures are judged separately according to the Commission’s guidelines
so the cumulative impacts of unilateral UK policies are not considered.
In order to comply with EU rules on state aid, UK support packages would have to involve,
amongst other things, either an energy efficiency benchmark, a requirement for all beneficiaries
to have signed Climate Change type agreements, or payment of at least 20 % of the costs they
are being exempted from.
Once these compensation schemes are defined, their persistence beyond 2015 are not
guaranteed.
The Chancellor of the Exchequer made a recent welcome commitment to preserving CCL
reduction rates for CCA members to 2023, in specific recognition of the long time-horizons for
investment.
7.7
Conclusions
UK energy and environmental policy is adding significant cost to cement and lime manufacture
relative to both EU counterparts and international competition. This is distorting the economics of
supply against UK companies and is encouraging carbon leakage.
These operational costs, and uncertainty surrounding energy and environmental policies are also
having an adverse impact on capital investment decisions in the UK. While some of this policy
uncertainty is shared with other EU cement and lime manufacturers, additional UK-specific
regulatory and tax burdens are compounding this problem in the UK.
Far from encouraging investment in new energy-efficient plant and promoting a transition to a low
carbon economy, there is mounting evidence to suggest that the cumulative effects of the UK’s
energy policy framework are having a corrosive impact on the investment climate and long term
viability of cement and lime sectors in the UK. Specifically, they are stifling investment and
innovation, exposing businesses to increased trade intensity from overseas geographies, and
accelerating carbon leakage.
According to Dr Martyn Kenny58, Sustainability Director at Lafarge Tarmac, “Cement and lime
manufacture are capital intensive operations with long pay back periods. Lafarge Tarmac’s
investors must choose between investing in UK manufacturing of importing. When assessing
investment risk and return, EU and UK policy uncertainty and uncompetitive energy prices can
drive energy intensive manufacturing investment out of the UK, impacting on the UK
Government’s growth ambitions and UK jobs.”
Proposed EU ETS, CPS and CfD support packages and their eligibility are still to be fully defined.
However, based on what is known, they will be inadequate in scale or duration to overcome the
adverse impact of policy measures on both operational costs and on the propensity to invest in the
UK relative to other jurisdictions
These conclusions complement those from the other case studies and the resulting
recommendations are reflected in Section 9 of this report.
58
Statement from Dr Kenny to authors of this report.
51
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
8
Paper sector case study
8.1
Introduction
Half of all paper making sites now make use of Combined Heat and Power (CHP) units on site, the
focus of this case study in the paper industry. CHP offers the potential for significant emissions
abatement. Around 6% of the UK’s power needs are currently met by industrial CHP installations
resulting in 15 million tonnes of carbon emissions abatement per year. Vast untapped potential
remains. In a recent study for DECC, Ricardo-AEA calculated that just a third of cost effective CHP
opportunities have been exploited.
Yet investment in CHP has stalled, in part due to unfavourable market price differentials between
gas and electricity, and in part due to energy and environmental policy changes. .
This case study at Northwood and WEPA examines these policy changes, which include the
removal of CHP climate change levy exemption certificates (LECs), and the introduction of CPS
costs on the fuel used to generate electricity in CHP plant. Their impact is illustrated by a specific
example from the paper industry.
Northwood and WEPA, the UK’s third largest manufacturer of private label, toilet tissue and kitchen
towel. It operates a modern paper mill and converting operations at Bridgend in South Wales, heat
and powered in part by a CHP plant
The conclusions and recommendations from this case study complement those from the other case
studies and are reflected in Section 9 of this report.
8.2
The CHP opportunity
Combined heat and power (CHP) offers the potential for significant emissions abatement, in
particular on large industrial sites that consume substantial quantities of heat. CHP plant integrate
the production of usable heat and electricity, into one single, highly efficient process, so reducing
fuel use and emissions by up to 30%59.
In 2011, the TUC and EIUG commissioned a report from the Centre for Low Carbon Futures 60 that
explored the low carbon technology solutions needed to deliver emissions abatement and secure
energy intensive industries in the UK. This found that increased use of CHP was critical to realising
reduced carbon emissions objectives, along with the use of biofuels and carbon capture and
storage (CCS).
Approximately 6% of the UK’s power needs are currently met by industrial CHP installations,
resulting in 15 million tonnes of carbon emissions abatement per year61, and a reduction in gas
imports of about 2%, providing a net balance of payments benefit of £165m.62 39% of UK CHP is
used in refining and 29 % in chemicals industries.63 CHP is also used in other heat intensive
sectors, including paper, ceramics and food and drink. At least 33% of chemicals, 50% of paper,
10% of food and drink, and 80% of refining companies utilise CHP. In total, there are
approximately 130,000 people employed on sites using CHP.
CHP can be sizeable. As an example, the Immingham CHP plant, supplying two refineries in
Humberside with heat, steam and power, was expanded in late 2009 to reach the same electricity
generating capacity as the UK's flagship nuclear power station, Sizewell B.
Vast untapped potential remains. In a recent study for DECC, Ricardo-AEA calculated the technical
potential of CHP at 29.4GWe in 2012 rising to 31.8GWe in 2020 and 33.8GWe in 2030 64. The
59
60
61
62
63
64
The Future of heating: Meeting the challenge, DECC, March 2013
Technology Innovation for Energy Intensive Industry in the UK, July 2011
DUKES, DECC, June 2013
CHPA analysis
Digest of UK Energy Statistics (DUKES), DECC, June 2013
Projections of CHP capacity and use to 2030, Ricardo-AEA /R/ED56126 Issue Number 1.2 Date 20/03/2013
52
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
current capacity of approximately 6.1GWe represents 21% of technical potential. The same study
found that the cost effective potential, based on a discount rate of 15% pre-tax over 10 years, was
18.1GWe (57% of technical potential) in 2020, rising to 20.1GWe (60% of technical potential) in
2030.
Investment in CHP in recent years has slowed, and growth projections to 2030 are modest (see
Table 4 below). In part this reflects unfavourable market price differentials between gas and
electricity, in which it is more economical to import electricity from the grid than invest in CHP.
However, it also reflects changes in policy as outlined below.
Capacity, GW
2010
2015
2020
2025
2030
October 2012 projection
6.1
8.1
8.6
-
-
September 2013 projection
6.0
7.7
8.4
9.2
Table 4: Updated projection of installed capacity of renewables and gas
8.3
8.8
CHP65
Energy and environmental policy and CHP
For most major industrial users, CHP represents the single biggest investment needed to realise a
step-change improvement in energy efficiency. However, the balance of cost and risk is weighed
against investment.
CHP plant are capital intensive (approximately £1 million per MW rising to £1.4m for plant below
50MW in size), requiring lengthy periods of investment return (typically 15 to 20 years). The
economics are defined by the cost of the principal combustion fuel, primarily gas, relative to the
value of heat and electricity generated. The price volatility of the primary combustion fuel and that
of the produced electricity impacts directly on the viability of the project. There is also a need to
factor in significant maintenance costs. A turbine typically requires refurbishment after 32,000
hours of operation. These costs alone amount to approximately 30% of the initial CHP plant cost.
In addition, new CHP plant are often located in areas where the electricity grid is constrained, so
increasing project costs and complexity.
Industrial CHP plant are typically designed to meet a heat demand, with excess electricity sold to
the grid. The electricity market interaction is a secondary activity for CHP operators and is viewed
as inherently risky.
Where a third party develops the CHP plant for an industrial user, not only does the developer
need to secure long-term power purchase agreements (PPAs), but it also needs to ensure that it
has long-term heat supply contracts in place with credit-worthy customers. As a result, CHP is
typically required to deliver higher investment return rates than conventional combined cycle gas
turbines (CCGTs) in order to secure financing.
Whilst CHP is more efficient that conventional heat and power generation, incentives are generally
needed in order to overcome these practical barriers to deployment
CHP is seen by most analysts as important to realising near term industrial emissions abatement
objectives. Until recently, the government sought to encourage investment in CHP for both carbon
emissions abatement and diversification of electricity supply purposes.
However, in Budget 2011 the Government announced plans to remove CHP Levy Exemption
Certificates (LECs) from the market, thus removing from April 2013 a key financial incentive to
invest in industrial CHP. The Treasury’s rationale was that the LECs were complex to administer
and costly to the taxpayer. The government indicated its intention to revisit CHP incentives for
existing plant, but has yet to do so.
The imposition of the CPF in April 2013 has further eroded the economic rationale for CHP.
According to the CHPA, taxes faced by industrial CHP plant have risen by £158 million in 2013.66
65
Updated energy and emissions projections 2013, DECC, September 2013
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/239937/uep_2013.pdf
66
Less waste, more jobs and growth; CHPA, 2013 http://www.chpa.co.uk/
53
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
This increase is up to three times greater than the increase for conventional gas power stations.
This is a consequence of the fact that the CPS is based on total fuel consumed in the power station
to produce electricity and, as a CHP plant uses extra fuel to deliver the same amount of power as a
CCGT, it faces a higher tax burden. The tax burden for CHP plant is also expected to grow, with
industrial sites using CHP seeing £262 million in tax by 2015.
These changes not only erode the incentive to invest in CHP, but impose charges on existing plant,
so undermining investor confidence. E.ON UK director of strategy and regulation, Sara Vaughan,
has gone on record to say that “[LEC removal] is a huge issue … It is giving us a financial penalty
on an investment that we have already made. That sort of thing does not give you much
encouragement to take further investments.”
CHPA are able to cite a number of further examples of the detrimental effect of these policies,
including instances where the introduction of CPS and removal of LEC have led to non-profitable
operations and proposals to shut plant.
8.4
The UK paper industry and CHP: Northwood and WEPA
The UK paper industry has suffered a steep decline. Between 2000 and 2010, half of the UK’s
paper mills closed, with the loss of thousands of jobs. Production fell by over a third and the UK
now imports twice as much paper as it produces.67
This decline has been halted in recent years, in part due to the construction of two new paper mills
and in part due to significant investment in energy efficiency, including CHP. Between 1990 and
2010 UK paper industry energy use was reduced by 34% per tonne of product and total emissions
by 42%, equivalent to 1.6m tonnes of carbon per annum. These efficiencies come, in part, from
investment in new plant. However, larger and more complex mills have also invested significant
sums of money in generating their own heat and electricity in CHP plant. Half of all paper making
sites now make use of CHP. Together they account for 7% of the total UK installed CHP electrical
capacity. An increasing number of mills also make use of waste materials to fuel their CHP plant.
Northwood and WEPA is the UK’s third largest manufacturer of private label, toilet tissue and
kitchen towel. It operates a modern paper mill and converting operations at Bridgend in South
Wales, heat and powered in part by a CHP plant.
The CHP plant, installed in 1995, was originally owned and operated by an independent developer,
RWE Cogen. It consisted of two gas turbines and two waste gas recovery boilers to generate
steam. Georgia Pacific, the previous owner of the Bridgend paper mill, purchased the plant from
RWE Cogen in July 2009, and it is now in the ownership of Northwood and WEPA. The turbines
have operated for a majority of the time since installation in 1995.
In 2001, the then Chancellor introduced CCL exemption for Good Quality CHP. Good quality CHP
refers to CHP generation that is energy efficient, as determined by the CHP Quality Assurance
programme (CHPQA).
Subsequent interpretation of the EU Cogeneration Directive in 2004, altered the basis on which
good quality CHP was defined in the UK, in order that CHPQA could comply with the higher
efficiency and increased heat bias specified in the Directive. In effect this moved the goal posts
and penalised companies such as Northwood and WEPA that had taken the brave step of installing
CHP, by altering the level of CCL exemption.
In common with most CHP plant of equivalent age, the Northwood and WEPA plant is now deemed
to fall slightly below the 100% Good Quality CHP threshold. As such, the company pays CCL on a
small proportion of fuel used.
Until recently, all electricity produced by CHP plant was exempt from CCL. The removal of LECs in
2013 meant that power sold to utilities, as opposed to being used in direct operations, is subject to
CCL. The Northwood and WEPA plant, in common with most industrial CHP is heat led. Were it not
for their ability to balance electricity supply and demand within the mill, this would result in
67
Confederation of paper industries (CPI)
54
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
additional costs. Most other CHP operations are less fortunate than Northwood and WEPA in this
regard.
The introduction of CPS for fuel used to generate electricity in CHP plant has added significant
further burden to Northwood and WEPA’s energy costs in 2014. These policy changes and their
impacts are illustrated in Figure 24 below, with the arrows shown in orange reflecting inputs or
outputs subject to CCL or CPS.
The combined effect of these policy changes substantially impacts upon existing CHP plant but
more importantly, undermines reinvestment economics in the CHP plant. Furthermore, regular and
sizeable policy changes that impact upon investment returns add risk and discourage investment
in new CHP capacity, similar to that outlined in the case study in Section 7.
Heat
Previous Arrangement:
Fuel
TFI - QFI
Electricity
Good Quality
CHP
Fuel
•
Fuel for Good Quality CHP (QFI) exempt
from CCL
•
Remaining fuel input (TFI-QFI) is subject to
CCL
•
Power output exempt from CCL (QPO)
TPO
QFI
Heat
Heat
Fuel
TFI - QFI
Good Quality
CHP
Fuel
QFI
Removal of LECs:
Electricity
•
Fuel for Good Quality CHP (QFI) exempt
from CCL
TPO - QPO
•
Remaining fuel input (TFI-QFI) is subject to
CCL
Electricity
•
Qualifying power (QPO) for directly
supplied electricity exempt from CCL
•
Power supplied to electricity utility subject
to CCL (TPO-QPO)
QPO
Heat
Introduction of CPF:
Heat
Fuel
TFI - QFI
Fuel
QFI/E
Fuel
QFI/H
•
Fuel used for Heat element of Good Quality
CHP (QFI/H) exempt from CCL and CPS
•
Fuel used for Electricity element of Good
Quality CHP (QFI/E) subject to CPS
•
Remaining fuel input (TFI-QFI) is subject to
CCL and CPS
•
Qualifying power (QPO) for directly
supplied electricity exempt from CCL
•
Power supplied to electricity utility subject
to CCL (TPO-QPO)
Electricity
TPO - QPO
Good Quality
CHP
Electricity
QPO
Heat
Key:
QFI:
Quality CHP fuel input
TFI:
Total fuel input
QFI/H:
Quality CHP fuel input for heat
QPO:
Directly supplied power output
QFI/E:
Quality CHP fuel input for electricity
TPO:
Total power output
Input or output subject to CCL or CPS
Figure 24: Recent policy impacts on CHP plants
55
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
8.5
Conclusions and recommendations
The Confederation of Paper Industries, in common with other energy intensive industry affiliated
organisations, has expressed significant concern that the cumulative effect of energy and
environmental policy measures, including the removal of CHP LECs and CPF, is undermining the
sector and that it will result in another period of significant decline and ‘offshoring of emissions 68.
CHP offers a significant opportunity to enhance UK industrial energy efficiency, reduce emissions,
and diversify electricity generation capacity. Recent policy changes have undermined new
investment prospects and disadvantaged existing installations.
DECC has acknowledged the need for a new policy mechanism if gas CHP is to realise its potential,
and the CHPA is working with the government in this area. Options include promoting CHP through
investment grants or heat incentives. However, this support will be limited to new CHP capacity. A
more immediate intervention is needed on behalf of existing generators to compensate for the loss
of LECs.
The CHPA has proposed exempting CHP from the CPS costs that it incurs on fuel used to generate
electricity. Their analysis, produced for HM Treasury, shows that relief on fuel used to generate
electricity from CPS begins to return the LEC value to CHP operators. This is illustrated in internal
rates of return (IRR) of the three real-world case studies given in Source: CHPA.
Table 5.
Project
Elec. Export
Relief from CPS
Benefit
Zero
100%
100%
60MWe Combined
45%
11%
15.8%
4.8%
10MWe Simple
10%
10.3%
16.8%
6.5%
+100MWe Combined
33%
8.3%
16.4%
8.1%
Source: CHPA.
Table 5: Impact of relief from CPS on fuel used to make electricity on project IRR 69
The manufacturer’s organisation, EEF, and numerous other industry bodies including the CBI, CIA,
FDF, PIA, and CPI have all called on the government to make investment in CHP more attractive,
and in particular to provide relief from the CPS on fuel used to make electricity. The TUC and EIUG
endorse this recommendation.
These conclusions and recommendations complement those from the other case studies and are
reflected in Section 9 of this report.
68
69
http://www.paper.org.uk/aboutcpi/communication/mps/MPs%20Briefing%20January%202014.pdf
CHPA analysis
56
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
9
Walking the Carbon tightrope: conclusions and recommendations
9.1
Conclusions
Energy intensive industries are the bedrock of the UK manufacturing sector. They are vital to our
successful transition to a low carbon economy, providing some 160,000 jobs directly and four
times this number in their supply chains. However, they face extraordinary pressures in coping
with the cumulative impact of climate change and energy policies.
Our case studies suggest that energy intensive industries are walking a tightrope from a high to a
low carbon economy. Government policy should, we argue, enable the transition rather than add
to its perils.
This report has examined through four detailed industry case studies the current impact of
government policies. Significant changes in policy direction are required to support these vital
industries to secure their just transition in a low carbon economy.
The TUC is committed to the realisation of a low carbon economy, securing our industrial base and
to the creation of new low carbon industries. However, it believes that this cannot be achieved
without sustaining energy-efficient EIIs in the UK.
The hard evidence from these four case studies suggests that well-intentioned energy and
environmental policies, and inadequate support packages, are adding significant cost to UK
manufacture relative to both EU counterparts and international competition. This is distorting the
economics of supply against UK companies:

Steelmaker Celsa has shared insights from their European operations that show that its UK
plant is one of the most energy and labour efficient in Europe, but that it faces the highest
electricity prices within the Group, in part due to the Carbon Price Floor and Renewables
Obligation. This is undermining the long-term prospects of this highly efficient, low carbon
business and adding unnecessary pressure to reduce labour costs. Details of energy prices
paid by the largest energy intensive companies are generally not in the public domain.

The most electro-intensive ceramics companies have already relocated away from the UK
due to high electricity costs. Recent trade data suggests that heavy clay sectors, such as
clay roof tiles and bricks, which have previously been less exposed to carbon leakage are
now seeing significant increases in imports.

The mineral products cement and lime sectors, in common with steel, heavy clay ceramics
and most other EIIs, are capital intensive operating on long investment cycles. There is
evidence that policy uncertainty and support mechanisms that extend no further that the
current Treasury spending review period in 2015 are adding risk and discouraging
investment.

Uncertainty, unilateral burdens on UK producers, and unrealistically short term relief
packages are corroding the investment climate and long term viability of these businesses.
In particular, they are stifling innovation and making offshoring of new investment a more
attractive proposition to multi-national parent companies.

Support packages are inadequate in scope. As an example, although some ceramics firms
are the most electro-intensive in Europe, about 85% of energy demand across the
ceramics sector as a whole is supplied by gas. As eligibility for support is currently defined
at a sector-wide level, these highly vulnerable installations are denied access to key parts
of the EU ETS and Carbon Price Floor support packages. Furthermore, using policy impacts
as a proportion of Gross Value Added (GVA) in order to determine eligibility for support,
discriminates very heavily against companies and sectors that are more labour-intensive,
creating further unintended distortions.

Policy changes on CHP have undermined incentives to deploy an effective and proven
means of industrial carbon emissions abatement.
57
Walking the carbon tightrope: energy intensive industries in a carbon constrained world
9.2
Recommendations
Government policy should, we argue, enable the low carbon transition rather than add to its perils.
Government, industry, Trades Unions and trade associations are aligned in terms of overall
objectives of delivering a low carbon future that is affordable to both industrial and domestic
consumers. However the challenge is putting this into practice, in ‘walking the carbon tightrope’
between creating the right environment to encourage investment in decarbonising energy supply,
and sustaining energy intensive industries in the UK. Both are needed in order to deliver our low
carbon future.
The UK’s heavy energy industries are generally mature, making use of similar manufacturing
processes and technologies across all countries. The primary routes to emissions reductions
include investing in the most up-to-date plant, deploying cross-sector emissions abatement
solutions such as Combined Heat and Power and carbon capture and storage (CCS) technology,
and minimising unnecessary transport of goods. The responsible approach is therefore to ensure
that UK heavy industries:
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Remain in the UK and do not succumb to leakage of jobs, investment and emissions.
Deploy the most carbon-efficient processes available to them.
Invest in innovation to reduce the environmental impact of their activities.
Have available proven and commercially viable cross-sector solutions such as CHP and
CCS.
Retain and develop highly skilled, well paid jobs in the UK.
Most EIIs supply commoditised products to internationally competitive and price-sensitive
markets, and are highly capital-intensive, dependent upon long term fiscal and regulatory stability
in order to attract investment. Many are multi-national concerns, with inter-company competition
for capital and operational investment. Given the above, Government policies need to:
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Ensure that energy prices faced by all levels of UK industry, and in particular EIIs, are no
higher than competitor nations in Europe and the rest of the World at all times
Shift policy from penalising energy intensive industries to encouraging investment in
energy efficiency
Deliver a long-term stable environment that encourages industry to invest in new plant,
innovation and emissions abatement, just as the Government is endeavouring to do for
nuclear and renewable energy sectors. Government policy should respect the fact that
investment cycles for EII can be several decades in length
Facilitate the development and encourage deployment of cross-sector carbon emissions
abatement solutions such as CHP and CCS.
Given the insights gained from these case studies, we believe that there is a need for a
fundamental re-think of Government policies. Current policies are having perverse and unintended
consequence of undermining investment in UK industry and having a long term corrosive impact
on competitiveness, so favouring imports and manufacturing in other jurisdictions, with the
resultant carbon leakage.
The evidence from these case studies would support near-term measures to limit the adverse
impact of energy and environmental policies on EIIs, whilst longer-term measures are considered.
To enable the transition of heavy industry to a low carbon future, we would recommend
that the government should:
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Freeze the CPF at its current level. The near doubling of CPS rates in 2014 and in 2015 is
unaffordable, and in the absence of State Aid approval for a long-term durable
compensation package, risks causing significant damage to the competitiveness of UK
electro-intensive industries. If state aid approval cannot be secured, CPF should be
abandoned
Extend and widen the scope of proposed compensation packages for electro-intensive
installations. Eligibility for compensation should be determined at a company, rather than
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Walking the carbon tightrope: energy intensive industries in a carbon constrained world
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a sector-wide level; and the duration of these measures should reflect the length of the
policy impacts that they are intended to mitigate and the investment cycles of the
industries concerned
Consult with industry on relief from the Renewables Obligation (RO), the main support
mechanism for larger scale renewable electricity projects in the UK, which also has a
considerable impact on industries’ costs. Subject to this, extend the scope of proposed
compensation packages to include RO costs.
Exempt CHP from the CPS costs that it incurs on fuel used to generate electricity. Given
the need for significant investment in electricity generation, and the proven efficiency
benefits of CHP, industrial CHP should be encouraged. Exempting CHP from CPS will
compensate for the recent removal of LECs.
Reduce complexity and risk by simplifying rationalising UK policies, including CPF, RO, CFD
FITs, CRC, and CCL into a single policy mechanism and support package.
Create a well-funded programme to support industrial energy efficiency and low carbon
solutions, with incentives for investment. The current reliance on driving energy efficiency
and carbon reduction through higher energy prices risks carbon leakage if undertaken
unilaterally in the UK.
Create a high level Energy Intensive Industries Council, with representation from industry,
trade unions and government, tasked with developing comprehensive long-term industrial
strategy to secure jobs, growth and the low carbon transition.
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