I am very pleased to have the opportunity to present the Electricity Regulation (Amendment) (Carbon Revenue Levy) Bill 2010 for consideration by the Seanad. Although it is a relatively short Bill, it has an extremely important purpose. It seeks to recover a substantial portion of the carbon windfall gains that electricity generators are currently receiving through the single electricity market, SEM.
Electricity generators are receiving these windfall gains because of a decision made in March 2008 by the SEM committee. This committee, which is comprised of energy regulators North and South alongside an independent and a deputy independent member, governs the operation of the all-island wholesale electricity market. It determined that regardless of how they receive their carbon allowances, electricity generators must include the full opportunity cost of carbon in wholesale electricity prices. In other words, electricity generators must pass on to consumers the price they would get for selling their carbon allowances on the open market.
However, as generators receive the vast majority of these carbon permits for free, the higher wholesale electricity price leads to increased profits for generators in the market without any significant commensurate cost. This is having a direct impact on the electricity prices paid by consumers. The SEM committee previously estimated that, assuming 100% of the cost of carbon allowances is reflected in the wholesale price of electricity and that the price of carbon allowances is €20 per tonne, prices are about 10% higher than they would have been in the absence of the European Union's emissions trading scheme.
The cost of carbon has declined considerably from its initial incorporation into wholesale prices but unlike other fossil fuels, particularly gas, it has somewhat recovered from its lowest point and today stands at approximately €15 per metric tonne. The incorporation of carbon is, therefore, having a real and measurable impact on the electricity prices paid by everyone in Ireland, from domestic consumers to the largest industrial undertakings.
As the SEM committee was set up to be a joint jurisdictional body it is not within our power to instruct it to reach an alternative decision. In fact, the committee's decision paper explicitly stated that it was up to governments to address the issue of windfall gains and noted that doing so would deliver benefits to consumers.
I do not object to the principle of including carbon in electricity prices. After all, it is only right that electricity prices should reflect the true cost of generating electricity, including the environmental impact of generation. However, allowing electricity generators to benefit from this without having to take any measures to cut their carbon emissions or pay for their carbon allowances creates an inequitable situation. This legislation seeks to recover these unearned carbon windfall gains. I am gratified that the opposition has to date supported my efforts to recover these carbon windfall gains.
The legislation has also been welcomed by economic commentators such as Richard Tol of the Economic and Social Research Institute, who stated:
Generally, windfall taxes should be avoided as they are arbitrary expropriation of private property. In this case, however, I fully agree with the Minister. Property rights on carbon dioxide emissions were created a few years ago. Although these rights used to belong to we the people, the European Union decided to give the permits, for free, to selected companies. This is tantamount to a subsidy worth billions of euros per year. Minister Ryan has now decided, rightly, to claw back this subsidy.
I propose to outline the methodology of how the levy is calculated and the reason we are taking this approach. The levy is calculated on a transparent and non-discriminatory basis. It will apply to all electricity generators operating in the single electricity market, SEM, which are receiving free carbon allowances and benefiting from the decision of the single electricity market committee.
The formula for calculating the carbon revenue levy is applied to all generators equally, based on the amount of emissions produced by a generator and the average price of carbon over the period the emissions were made. The actual amounts payable by an electricity generator levy will vary from generator to generator.
In an ideal world, rather than allocating allowances free of charge, we would prefer to charge the market rate for any allowances participants receive. However, the European Union as a whole has determined that emissions trading scheme, ETS, participants are entitled to at least 90% of their carbon allowances free of charge during phase two of the ETS which runs from 2008 to 2012. This was set out in article 10 of the EU emissions trading directive — Directive 2003/87/EC — which was created to implement the cap and trade scheme across the EU.
Article 10 of this directive states that for the three-year period beginning 1 January 2005, member states shall allocate at least 95% of the allowances free of charge and for the five-year period beginning 1 January 2008, they shall allocate at least 90% of the allowances free of charge. Any moves to limit or remove this provision would thus be in direct contravention of a European directive and could not be expected to survive a legal challenge. Therefore, in constructing the carbon revenue levy we have been careful to avoid any measures which could be seen to interfere or limit this entitlement to free allowances. This is the reason the levy is based on generators' emissions rather than a direct tax.
This may seem to be a minor point but it is a key distinction. We are addressing the windfall gains arising from the SEM committee decision, not the basis of the ETS itself, that is, the free allowances. Generators will be required to pay the carbon levy on a quarterly basis. It will be based upon their carbon emissions, multiplied by the average price of carbon over the relevant quarter and adjusted by a further percentage rate. This rate has been set in the legislation at 65%, although the Minister has the power to review this percentage.
The percentage rate of 65% specified in the legislation was chosen for a reason. Setting the rate at this level allows us to recover a substantial portion of the windfall gains from generators but should also ensure that we avoid excessive recovery of funds. As indicated, the easiest and most precise solution would be to charge electricity generators the market price for each free carbon allowance they receive. However, since interference with EU directives would be legally impossible we cannot levy the free allowances and for this reason we had to consider other options.
The market structure of the SEM means that the precise quantification of the windfall gain for each generator in each half hour period would be a technical and administrative nightmare and require significant time and resources to accomplish, if it is even possible. Further complicating this issue is the fact that a generator may have had to purchase a portion of the carbon allowances it is using.
Generators receive their free carbon allocation from the Environmental Protection Agency based on the national allocation plans. The current plan, which covers the period 2008 to 2012, based allowances to generators on an average of their output over the period 2003-04. Whether a generator is required to purchase additional allowances therefore depends upon how much its current output varies from this historical output. Needless to say, if a generator has had to purchase allowances on the market, it will not be earning windfall gains on that portion of its allowances.
We also face the difficulty whereby a certain proportion of the emissions from each generator would be attributable to in-house consumption, that is, electricity that is consumed directly by the generator and not sold into the market. Since it is not sold into the market, generators are not earning a return for this output yet are required to surrender allowances for it. Therefore, there is no windfall gain for this element of a generator's emissions.
It should be remembered that generators are required to bid in opportunity costs of carbon on a day ahead basis. All scheduled generators then receive the system marginal price. The system marginal price, therefore, reflects the anticipated opportunity cost of carbon of the marginal plant. However, the method of calculation for the levy is the simple arithmetic average of the daily price of carbon allowances over the levy period rather than what generators actually bid and receive for carbon. While the difference between the two figures is unlikely to be significant, it is yet another abstraction we have had to create to ensure the levy can work effectively in practice.
For these reasons, we have had to adjust the levy amount downwards by a percentage rate and 65% is our best estimate of a figure that raises significant levy proceeds while avoiding excessive recovery. This rate can be modified by ministerial order, following advice from the Commission on the operation of the levy and a public consultation.
After listening to the concerns expressed by Deputies on Second and Committee Stages regarding the application of the levy to plant covered by public service obligation or PSO orders, the Minister conducted a further review of all ongoing public service obligation contracts to confirm that no generator is benefiting from the Commission decision on carbon costs. As a result of this investigation, it was determined that two electricity generators covered by the public service obligation could have the opportunity to benefit to a small degree from the SEM committee decision requiring generators to pass through the opportunity cost of carbon. The generators in question are Aughinish Alumina and Tynagh. These two generators will benefit if they sell a small proportion of their output outside the PSO scheme. They are thus earning carbon windfall gains on this small portion of their output as it is sold directly into the wholesale pool and the generators receive the market price for it, which includes the opportunity cost of carbon.
To address this matter, the Report Stage amendments introduced by the Minister limit the exemption for certain qualifying PSO plant. Any output which is sold into the market and is outside the scope of the capacity and differences agreements or PSO contract these companies have with ESB will now be subject to the levy. In practice, the two companies' levy liabilities are likely to be very small since the vast majority of their output in both cases is subject to their PSO contract.
I stated earlier that the overarching goal for this legislation is to create a fully transparent levy that recovers a substantial portion of carbon windfall gains while treating generators equitably. The amendments made on Report Stage in the Dáil ensure that no emissions producing generators benefiting from the SEM committee decision on carbon costs are exempt from the levy.
The only electricity generators remaining that do not have to pay the carbon levy are those covered by a PSO order made under section 39 of the Electricity Regulation Act. These generators are excluded because they do not earn carbon windfall gains and, as such, there is no underlying rationale for including them in the carbon revenue levy.
PSO generators do not earn carbon windfall gains because they do not earn revenues from the market in the same way as other generators. Rather they receive a guaranteed fixed return. This fixed return is generally above the prevailing system marginal price. Hence, when fossil fuel prices are high and the market price is high there is little or no premium paid to these PSO plant. However, when market prices are low this premium can be large.
The effect of the SEM committee decision requiring generators to incorporate the opportunity cost of carbon into electricity prices was to raise the wholesale cost of electricity, similarly to what would have been the case had there been an increase in fossil fuel prices. This directly reduced the cost of the PSO levy to consumers. Therefore while overall compensation to PSO plant was unchanged, the cost of the PSO to consumers declined by that portion of the rise in electricity prices that was attributable to carbon. As a result, electricity consumers rather than the PSO plant benefited from the incorporation of carbon.
Imposing the carbon levy on the PSO plant would essentially be a zero sum game. The amounts we would collect from the PSO plant by applying the carbon levy to them would be passed directly on to consumers through an increase in the PSO levy. The levy applies to all consumers. The Minister has stated we will use the funds raised by the levy to offset electricity prices for large energy users. Therefore imposing the levy upon PSO plant would raise prices to domestic consumers while the increased revenue from this would reduce electricity prices for large energy users. This would be an additional burden on consumers and given that the removal of the exemption would have no impact on the operation of the peat plant and steps have already been taken to address the small amount of windfall gains being earned by other PSO generators, the Minister is satisfied that the treatment of PSO plant in this legislation is justifiable and equitable.
Funds raised by the levy will go into or be used for the benefit of the Exchequer. This provision is similar to those contained in the legislation dealing with the disbursement of dividends from the State energy companies, for example. Any funds from the levy will be disbursed with the full consent of the Minister for Finance. It will be done in a clear and transparent fashion and will be fully reported on in the accounts for the levy account which are to be audited by the Comptroller and Auditor General and laid before the Houses of the Oireachtas on an annual basis. The Minister has signalled his intent to use funds raised by the levy to protect the competitiveness of Irish enterprise. Electricity costs form a key part of the competitive pressures on enterprise in Ireland, particularly on energy-intensive exporters or those that are part of large multinationals which regularly review and benchmark costs across multiple locations. The Government is of the view that it is imperative to take all possible actions to support the enterprise sector and employment by focusing efforts on reducing costs where we can for large energy users which are typically significant employers with both indigenous and multinational bases.
This levy is a temporary measure and will come to an end at the close of 2012, as after that date all carbon allowances will be auctioned, rather than allocated to generators for free. This will ensure the true value of carbon is factored into European electricity prices. It will end the issue of windfall profits for electricity generators and add an additional incentive for investment in low carbon electricity generation. It is hoped to enact the legislation by the end of June. For every month the legislation is not enacted, approximately €6 million to €7 million will be lost to the levy and electricity generators will continue to enjoy these unearned windfall gains.
Although we have made major strides in improving our energy cost competitiveness in the past 12 months, we cannot become complacent. The Bill is a vital measure that will deliver a tangible boost to the competitiveness of Irish industry. The Minister will be working closely with the CER to ensure the speedy implementation of the Bill's provisions, following enactment.
Elsewhere in the market we have more than 800 MW of new and highly efficient generation capacity coming on-line. The new ESB Aghada station was officially opened recently and the Bord Gáis Éireann plant in Whitegate will open in the coming months. There will be no shortage of competition between efficient generators in the SEM this year, as these new generators, with significant new wind power capacity, will help to reduce carbon emissions and provide benefits for all electricity consumers. This new investment, combined with the measures in the legislation, will ensure the future outlook for Irish energy prices will remain positive. I look forward to hearing the views of Senators on the legislation.