Climate change and the challenge for business

Speech by Chris Huhne MP, Shadow Environment Secretary delivered to Centre Forum, Bloomberg centre, London on Tue 9th May 2006

Climate change has been a serious issue of policy concern for twenty years. The Intergovernmental Panel on Climate Change was established in 1988. Its first assessment report, completed in 1990, served as the basis of the United Nations Framework Convention on Climate Change signed in Rio De Janeiro in 1992. Most of the international community has been persuaded of the science, and of the cost-benefit calculus in proceeding to a framework of greenhouse gas reduction as mandated by the Kyoto Protocol. Some countries have gone astonishingly far towards a new green future. In Sweden, it is now realistic to talk about a fossil-free and nuclear-free future within fifteen years. Germany and Denmark have made enormous strides in installing wind power, and are phasing out nuclear energy. As an issue, climate change has suddenly become central to the political debate in what were hitherto laggard countries like Britain and the United States, and that is quite right.

Climate change cannot be brushed aside as not worth the cost of prevention, which is the argument of Bjorn Lomborg in The Skeptical Environmentalist. The most recent science indicates that some of the risks are more serious than had first appeared. Let me mention two in particular, the first general and the second specific to the UK and North Western Europe. Some risks if they happen would be irreversible and would speed up climate change: for example, the release of greenhouse gases from thawing permafrost or dying Amazon rainforest. Since CO2 lasts as long as a century, sharp releases cannot suddenly be counteracted. These scenarios could lead to warming at least twice as fast as the high-emissions projections, and the consequences would indeed be catastrophic. Sea level rise and flooding, extreme weather events, desertification and drought would all follow. There is a strong case for urgent action to head off these extreme scenarios, as Sir Nick Stern is likely to find when he finishes his report on the economics of climate change.

There is another scenario for the UK which suggests that the costs could be different, and also greater. The Gulf Stream is crucial to Britain's climate, as it brings more heat to these islands each winter than all the sunshine. Yet the Gulf stream is driven by salty water sinking near Greenland and drawing warm water northwards. If the salty water is diluted by melting glacial fresh water, the conveyor belt could stop, plunging Britain into very cold climates similar to other areas as far north as we are such as Newfoundland and Labrador. According to work by Harry Bryden and his team at the National Oceanography Centre in Southampton - the largest marine research institute in Europe - a switch off of the Gulf Stream could cut average temperatures in Britain by 4 to 6 degrees, with a particular effect on winter with temperatures down by 10 degrees.

It could happen in as little as 20 years, dwarfing the impact of global warming on the UK's temperature. The latest research shows that the strength of the cold water returning from the Arctic has fallen by 30 per cent since 1992. Measurements taken last year were compared with 1957, 1981, 1992 and 1998. Over the same period, the flow of warm water being diverted towards Africa has increased by 30 per cent.

How do we analyse these problems from an economic and business point of view? First, there is a clear need for change to avoid potentially catastrophic consequences or externalities. There is also, by the way, a strong moral argument in equity for urgent action as some of the most devastating consequences of drought and crop failure would be in some of the poorest countries of the world.

Broadly, it seems to me that the case for heading off high-emissions scenarios such as 550 parts of carbon dioxide per million - we are currently at about 425 - is now overwhelming. It is the very least we need to stabilise global temperatures at a 3 to 4 degree rise compared with pre-industrial levels. But how do we do it?

The first policy question is how to do it. There is clearly a collective action problem familiar to economists: how do we reach agreement with the United States, China and India as big emitters? How do we avoid free riders merely assuming that others will do the work of cutting greenhouse gases? Secondly, what are the appropriate instruments to achieve global change? What is the right balance between markets, taxes and regulation, all of which can play a role? What will best provide the social incentives to sustainability that business needs? How do we harness the creativity of business to reach solutions? Let me deal with each of these in turn.

There is only one solution to a collective action problem, which is persuasion. It may be too late, but it is happening. In the United States, the Bush administration looks increasingly beleaguered in its attitudes towards global warming. There is an initiative for a voluntary carbon trading scheme in the North Eastern states, and there are many state-wide initiatives notably in California for reducing emissions. China is increasingly aware of the problem, as recent speeches from senior leaders and its support for Kyoto (which admittedly does not impose emissions limits on developing countries) shows. For example, China has set the goal of halving the energy intensity of GDP by 2020 and has entered into agreements with both the EU and the USA on climate change including new technologies.

That persuasion has to be towards a framework which is both equitable and sustainable: so-called contraction and convergence. Contraction to a level that delivers an equilibrium ideally well below 550 ppm, and convergence because there can be no moral case for capping a Chinese person's average emissions at 10 per cent of an American's. Within that framework, there should be plenty of flexibility about how we deliver.

In Europe, one important mechanism that covers about 46 per cent of all the UK's carbon emissions is the Emissions Trading Scheme. Essentially, permits are granted on a baseline of emissions from power stations, pulp and paper, refineries, cement, iron and steel. The ETS first phase is underway from 2005 to 2008, and the caps are currently being considered and should be set so that the carbon price continues to provide real incentives to save emissions. Given the recent falls from some €25-30 euros per tonne of carbon to some €15 euros per tonne, the ETS still has some teething problems if it is provide a sensible and sustained incentive to change.

In principle, though, the ETS is an excellent mechanism. It allows firms that can save emissions to do so and sell their surplus. It therefore should be acting, in an economically rational way, on the easiest targets for emissions. However, the ETS does not cover the 22 per cent of emissions from road transport. Nor aviation.

We have to continue to act on the other half of the UK's emissions, and we should try to use pricing mechanisms precisely because of the same advantage as the ETS: they price out the marginal uses of emissions. That is why the Liberal Democrats are the only mainstream political party to have bitten the bullet on the use of green taxes to help change our behaviour.

The fall of green taxes as a percentage of GDP from 3.6 per cent in 2000 to 3 per cent in the latest figures is perhaps the most compelling evidence of the Labour government's failure to take climate change seriously. Even the recent budget announced only that the climate change levy would rise in line with inflation for the first time since its introduction in 2000, while fuel duty would also just rise in line with inflation. Vehicle excise duty is planned to fall in cash yield by £10 million. Most scandalously, the air passenger duty has declined by 35 per cent between 2000 and 2004 despite an 8 per cent increase in passengers.

By contrast, we have proposed an amendment to the Finance Bill which would involve a sharp increase in Band G of VED to £2000 on new cars in order to change over time the nature of the car pool, together with revalorisation of fuel duty and the climate change levy. We would reshape the air passenger duty so that there was a fixed charge for each aircraft movement depending on its emissions, thereby providing a strong incentive to high load factors. Over time, we are committed to reversing the fall in green taxes as a percentage of GDP so that we provide real market incentives to both the transport and the housing sector.

There is also a role for regulation. The voluntary agreement in the car industry to get car emissions down to 140 grammes per kilometre on average is unlikely to bite without a re-examination of EU standards, and we believe that the target in any case needs to be more radical. The same applies to the new building regulations, which are still far less environmentally demanding in Britain than elsewhere. If there are to be serious price incentives for households - by extending the carbon levy to them - then we must develop a way of tackling pensioner fuel poverty since the variation in use from one poor pensioner to another is by a factor of six thanks to heating inefficiencies and poor insulation. The process of policy-making for the aversion of climate change is necessarily complex, and pulls in many Whitehall departments: Defra of course but also the Treasury, Transport, Office of the Deputy Prime Minister and the Department of Trade and Industry.

Should business be scared of the prospect? I hope not. The role of the Government is to set a consistent market-friendly framework, through the use of market incentives like the emissions trading scheme, green taxes and regulation, that helps to shape business activity in a sustainable way. There should be no nonsense about being anti-growth: wind turbines, tidal power generators, photovoltaic cell panels and insulating materials all contribute to growth. Growth is the residual, and all we are doing with a green framework is directing growth towards sustainable and socially warranted aims. Car crashes boost GDP, but we aim to avoid them. Hitmen boost GDP, but we lock them up. There is nothing new in principle about using the law to channel activities towards socially desirable ends.

Green businesses offer some of the best growth prospects of any over the coming decades, and any economy that invests early will have all the advantages - and potential market gains - of the first mover. Some technologies are self-evidently more likely to thrive in Britain than others. The British Wind Energy Association is a formidable trade body numbering hundreds of firms with an interest in this fast-growing technology, both onshore and offshore. Other new technologies are coming on stream: one interesting new technology that may help is carbon capture, which would involve taking the carbon dioxide emitted from power stations and pumping it into the oil and gas wells under the North Sea where there is enough space to store from 70 to 200 years of Europe's carbon emissions. A consortium including BP has said it wants to build a pilot plant at Peterhead. The Emissions Trading Scheme has already opened up opportunities here in the City for traders and investors, and the possibility of a market that will soon dwarf almost every other commodity market.

All these elements of the new green marketplace offer great opportunities for Britain as a whole and the City in particular, whether for venture capital, or for high risk bond finance or AIM listings. Climate change capital is a boutique investment bank that offers asset management, venture capital and corporate finance: it will certainly be a pioneer of many.

Nor is greening something that can only be done by businesses producing green products and processes. Every business has an interest in cutting costs, and basic measures can bring surprising economies. Many factories and warehouses are now fitting wind turbines to cut their drawdown from the grid. Merely encouraging staff to turn off lights where possible and make good use of daylight can reduce lighting costs by up to 19% and save enough CO2 to fill a double decker bus every year. Replacing ten standard bulbs with low-energy bulbs can save £65 a year in lighting costs, and a lot of emissions. You can turn down the heating. You can turn off equipment rather than leave it on standby. These are win-wins for business.

There are many examples of where business has acted, and where there has been a win-win. BP spent £20m to implement its energy reduction strategy between 1998 and 2001, but in the process realized almost £650m in financial savings in just three years - meeting targets a whole nine years early. As Chris Mottershead, one of their senior advisers, said: "The fact that the target was delivered nine years early was simply because remarkably good business … It is about creating value, not about the cost of mitigating emissions." Dupont is another case in hand. Investment in energy efficiency allowed the company to hold energy use constant between 1990 and 2000, yet increased production by 35% and saved the company £2bn. There is no single magic bullet for these successes. The most common gains appear to come from energy efficiency measures - building and process design waste-reduction and incentives for using alternative sources energy sources.

Five leading companies of the 22 examined in a recent study had achieved reductions of 60% or more in energy use, with savings of more than $5.5 billion. These companies were DuPont, Alcan, British Telecom (BT), IBM, and Norske Canada.

Businesses are marvellously flexible and adaptable faced with the right incentives to act, but those incentives have to be consistent. Businesses have to be confident, if they are to invest, that the lie of the land will not change between the decision and the realisation. That is one reason why it would be so desirable to have a cross -party consensus on climate change. These are long-term issues. However, the debate is moving and rhetoric does ultimately determine what people do. With both Conservatives and Labour now waking up to the importance of climate change and the greening of Britain, new business opportunities are continuing to open up.