My Lords, with the leave of the House, I shall repeat a Statement made earlier in Another place by the Secretary of State for Environment, Food and Rural Affairs. The Statement is as follows:

"Mr Speaker, I would like to make an announcement about our proposals for the second phase of the European Union Emissions Trading Scheme. Today we are announcing the level of our cap. In due course, we will present to the Commission our full and formal national allocation plan.

"The case for tackling climate change, and the human contribution to it, is overwhelming. The scientific consensus is wide and deep, and the need for international and domestic action, across all aspects of economic and social life, is very strong. In the UK, we can take pride that we are projected to cut our emissions of greenhouses gases by 23 to 25 per cent from 1990 levels over the Kyoto commitment period. That is nearly double the level of the Kyoto targets. However, UK emissions of carbon dioxide are rising. We remain on track to meet our Kyoto targets, but we will, on current trends, fall short of our national goal of a 20 per cent reduction in CO2 emissions by 2010. Our challenge is to take action now to avoid the environmental but also economic and social costs of inaction.

"The EU Emissions Trading Scheme is the cornerstone of a Europe-wide drive to reduce emissions from high energy intensive sectors. It currently covers around 11,000 installations across Europe, and companies in the scheme in the UK account for some 45 per cent of UK carbon dioxide emissions. The Emissions Trading Scheme gives a clear incentive to industry to invest in low carbon technologies of the future, but achieves carbon reductions at the lowest possible cost.

"We are now in the second year of the first phase of the scheme. The results from year one have provided a first opportunity to judge allocation against emissions and most member states' caps for phase 1 do not provide the scarcity the scheme demands. The UK cap was 245 million tonnes, and our system has worked well. The Government imposed the shortfall in allowances on the electricity supply industry and all other sectors were allocated according to need. And, as intended, all but the electricity supply sector are living within their allocations.

"The Commission has used the information from the first phase to assess what member states' caps should be for phase 2 and set out indicative figures that require substantial cuts from most member states. Phase 1 was in many ways a trial period. Phase 2 coincides with the first Kyoto period (2008-12) and states which do not take the measures necessary within this period to reach their Kyoto targets will either have to purchase Kyoto allowances and credits from other states or will face penalties for missing targets.

"In March, in our consultation on the draft national allocation plan, we set out a range of UK reductions of emissions during phase 2, from 3 million tonnes of carbon to 8 million tonnes. At the time of consultation this was equivalent to a cap of 234 million to 252 million allowances a year, representing 234 million to 252 million tonnes of CO2.

"There have been important changes since we published the draft national allocation plan. Our projections for emissions in 2010 have risen by 3 million tonnes of carbon for the UK as a whole, and by 1.1 million tonnes of carbon for the installations covered by the EU Emissions Trading Scheme.

"In these circumstances, we believe it is essential to make the maximum effort consistent with the range on which we consulted; in other words, reductions of 8 million tonnes of carbon per year below business as usual, equivalent to a reduction of 29 million tonnes of carbon dioxide. That is now, since the change in projections, equivalent to an annual allocation of 238 million allowances to UK installations covered by the scheme in phase 1. These figures may change slightly to reflect the expansion of the scheme and removal of those installations that emit the smallest amounts of carbon dioxide.

"We have looked carefully at the possible effects on business and consumers before making our final decision. Our intention is that, for industrial sectors, which include those most open to international competition, allocations should continue to be on the basis of need. In respect of electricity supply, however, the sector is mainly insulated from international competition and this sector's allowances could therefore be set at a lower level, and be subject to auctioning.

"Phase 2 of the Emissions Trading Scheme allows for a maximum level of auctioning of allowances of 10 per cent. We propose to set the level of auctioning in the UK at 7 per cent. Obviously, the final amount raised by the auction cannot be determined in advance, but it will be substantial.

"We will build on the trading scheme agreement and go further. We believe there is a major opportunity for the UK not just to invest in renewable energy, other non-nuclear low carbon technologies and energy efficiency, but also to build successful businesses in these fields. We will establish a new joint Defra/DTI environmental transformation fund, administered by my Right Honourable Friend the Trade and Industry Secretary and myself, to grasp this opportunity. Final details of the scale and scope of the fund will be announced in the spending review for implementation, like the Emissions Trading Scheme, in 2008.

"The EU Emissions Trading Scheme is also linked to a global carbon market and has been a major driver in its development. Project credits—which are credits generated in developing countries through the clean development mechanism, or in other developed countries by joint implementation projects—may be used to help meet the caps set for operators. The use of these credits provides a driver for sustainable energy projects in the developing world and for technology transfer. However, member states need to ensure a balance between domestic and international effort. UK companies are already at the forefront of this market and we want that to continue.

"In the UK we are providing for the use of these credits to meet up to 66 per cent of the effort in phase 2. In effect, this means that 5.3 million tonnes of carbon—that is, about 19.5 million tonnes of carbon dioxide—from clean development and joint implementation projects can be used, which is equivalent to 8 per cent of the total cap. All installations in the UK may use project credits to meet emissions up to 8 per cent of their allocation.

"The EU Emissions Trading Scheme has an impact on electricity prices via the cost of carbon allowances. That cost is driven by the cumulative effect of all member states' decisions, not by the decision of any individual member state for the citizens of that country. Many factors drive electricity prices, including global fuel prices and the weather. But our estimate is that the impact of the proposal, relative to the phase 1 cap, will be a one-off rise in industrial energy prices in the region of 1 per cent, and approximately half that for domestic users.

"Our decision to set the cap at the top end of the range of effort on which we consulted sends a clear message that the emissions trading scheme is here to stay, that the Government are committed to making it work, providing clear, progressive rewards for a shift to low-carbon technologies, and that the UK is determined to maintain its leadership role on this issue. Today's decision will set us on course to deliver a 16.2 per cent reduction in emissions, against 1990 figures, by 2010. We said when we launched the climate change programme review in March this year that it was not the last word. We will use further opportunities, including the energy review and the environmental transformation fund, to help us move progressively towards our 2010 target.

"EU member states are required to use emissions trading as a means to deliver their Kyoto Protocol commitments for 2008 to 2012. The level of ambition that individual member states set for the reductions to be made by the sectors covered by emissions trading will be an important element in the price of carbon allowances. Now that member states will need to show that they are meeting their Kyoto targets, and with the Commission having phase 1 emissions data, the UK will expect to see more stringent caps enforced in phase 2. We will therefore encourage and support the European Commission in its efforts to ensure tough caps, to provide greater long-term certainty, to help the smooth running of the trading system, and to avoid potential competitive distortions. I spoke to Commissioner Dimas this morning to emphasise this point. It is important that, in the EU, we all push together for a trading scheme which delivers real emission reductions.

"Phase 2 also forms an important element in the broader consideration of our long-term carbon policy framework. Concurrently, my Right Honourable friend the Trade and Industry Secretary will next month be reporting the findings of the energy review, in which the Government are reviewing the UK's progress against the medium and long-term energy white paper goals, including our 2050 carbon reduction goal, and the options for further steps to achieve them.

"My right Honourable Friend the Prime Minister has made clear that climate change is a global problem that requires a global solution. This target for phase 2 will support the development of the global carbon market, and we will therefore continue to work with our EU partners to ensure that negotiations for future commitments under the Kyoto Protocol make clear and convincing progress. We will continue to work through the Gleneagles dialogue launched through the UK presidency of the G8 to search for consensus on the practical measures for tackling climate change. The case for taking action is overwhelming. The speed at which the world responds to that case will determine the effectiveness and the positive economic impact of our response. Today's announcement takes another step towards our long-term objective of a 60 per cent reduction in carbon dioxide emissions by 2050".

My Lords, that concludes the Statement.

My Lords, I thank the Minister for repeating the Statement made by his Right Honourable Friend in Another place two or three hours ago. It is no less welcome for the fact that it has come as a surprise to most of those working in this field. Inevitably, with a Statement of some length and considerable detail, it gives rise to a number of questions.

The collapse of the emissions trading market early this year highlighted the weakness of the approach of the European nation states to the allocation process in phase 1. It also highlighted the weakness of the Commission's position on adjudication and control of those bids, which is what they were at that stage. The effect in the market was a huge loss of faith in emissions trading as a scheme to limit carbon dioxide emissions. We cannot afford that. It also caused considerable loss of faith in the intention and determination of mainland European nations to tackle and limit their emissions of carbon dioxide. We cannot afford that either. Phase 2 must work to much greater effect than phase 1 was able to do.

In those circumstances, one has to ask whether the Government are satisfied about the determination of the European Commission to ensure that it arrives at allocations that will be effective at nation-state level. In phase 1, there was some question about who was responsible and whether nation states could bid or the Commission should set the target. Are the Government now satisfied that other nation states in Europe are sufficiently determined to set realistic targets to make this scheme work? Once again, we cannot afford any failure in that regard.

Finally, are the Government satisfied that the European Commission has a sufficiently robust system of audit that is—to borrow a phrase from the Government—"fit for purpose" to ensure that the operation of phase 2 will be real and effective, which phase 1 was not?

I welcome the Government's intention to auction a proportion of the allocations in this new phase. The Commission permits the auctioning of up to 10 per cent of the allocation. It would be interesting to know why and how the Government arrived at 7 per cent. That said, having this earlier income from the sale of credits that people have to purchase at an assessed value must help to create a more realistic market, provided the total of the allocations is correct. In another place, the Minister's Right Honourable friend the Secretary of State guesstimated—I think that would be the term—that the auction might produce about £150 million. It would be interesting to know whether the Government have any ideas about how those funds might be used. It is essential that that income, which comes with the direct purpose of limiting carbon emissions, should be used to fund schemes that will aid that purpose. However, I am all too aware that dedicating funds for a particular purpose when they come in is rather difficult for the Treasury, which prefers to take money into the general fund and then reallocate it, often to something rather different.

I also note the creation of the Defra/DTI Environmental Transformation Fund. We do not yet know how resourced it is to be or whether it is to be used only for investment in the general renewable energy field, although it looks as though that might be the case. Most importantly, we do not know what will be its relationship to the Carbon Trust and others who are already working in the field. It would be interesting if the Minister could give us more information on that.

This is a helpful Statement. It is a move in the right direction. It is to be hoped that phase 2 will work properly. I look forward to the Minister's reply.

My Lords, we on these Benches also welcome the Statement. It gives us just the skeleton and will be fleshed out by the formal national allocation plan and a lot of my questions will be reserved for that phase of the business. However, phase 2 is important and is one of the main tools that this country has for getting us on track to meet our Kyoto targets. Now that we have reached phase 2, we have to avoid some of the failures of phase 1.

One of the most difficult things across industry and for the public of phase 1 is that it was not very clear that the polluter pays. This issue got lost in a blizzard of figures, percentages and statistics. People really want to know whether this is being effective in reducing carbons admissions.

The Minister said that the provision would cover 45 per cent of our emissions of the sectors included. That is critical. The Minister has been silent on a couple of areas because they will fall within the fuller plan, and on whether aviation and transport in any form will be included in the full plan. There is a disconnect with which the Government I am sure struggle, which is common in every government in Europe—that is, we have national allocation plans within a single market.

At the moment energy and the allocating plans are a national matter. That makes it very difficult. Will the Minister give his reaction to the setting of the German levels? When we reach phase 3, will there be any thought of setting the levels at a European level and therefore making sure that no country falls for the temptation of setting a lower level on the basis of safeguarding its industries?

I was cheered to hear the Minister make the announcement about the Defra/DTI environmental transformation fund. Is the intention that the auctioning process will produce the revenue for the fund? It was not clear to me where the revenue would come from. I imagine that the Government have thought about the size of the fund. I see that the scale and scope of it will be announced in the spending review for implementation in 2008, so there is a while to wait. Will the Minister give some idea where the proceeds from the auction will go?

I have a couple of final questions on the shape of the national allocation plan. What incentives will there be to ensure that new entrants invest in low-carbon fuels and efficient technologies? Again for new entrants, will there be clear definitions and consistent applications of the relevant provisions to support incentive structures and fairness? For the plants for which closure is the only option, will this scheme sufficiently push to close those old, inefficient and highly polluting plants?

These Benches welcome this very important tool. It takes us through to 2012. If the first phase was a learning curve for not making the same mistakes in the second phase, perhaps it is disappointing that we have not ironed out all the faults. Early on in this 2007–08 period we must ensure that by the time we get into the post-Kyoto scenario, which will be phase 3, the scheme is as perfect as possible at a European level.

My Lords, I am grateful for the responses of the noble Lord and the noble Baroness, not least because they have kept off some of the technical stuff in what is quite a complicated Statement. I am doubly grateful to the noble Baroness because she opened her remarks by saying that she would save most of her questions for when we make the final allocation plan, which has to be done by 31 December. I look forward to being more onboard then.

I am very pleased that nobody has questioned that there is a real problem—that is very important for business and the wider population. There is a major problem out there; the science is clearly with us; and there are disputes about it. On a visit to one of the department's laboratories the other day, I came across a couple of facts that have stayed with me. Things were explained in a way that puts the matter across to ordinary bods and industry. For example, the amount of fresh water lost from the Greenland ice cap in recent years is enough to cover France to a depth of 35 kilometres. That is an enormous change. The other fact is that of the 10 hottest years ever recorded, nine of them were in the past 10 years. So something is happening out there which we must get a grip on. Climate change is a major issue.

I did not understand the surprise of the noble Lord, Lord Dixon Smith, about the Statement. We were obliged to make a Statement by 30 June, and we have done so. We have met that commitment.

We did a lot more than others in phase 1 and the proposed cap moves us towards our domestic target and confirms our position as leaders in the climate change debate. We make no apology for wanting to be a leader in the debate, as the Prime Minister has made absolutely clear. The commission has sent a very strong message about expectations of member states. Colleagues are quite right to ask about that.

The recent article in the Financial Times by Commissioner Dimas stated that the Commission will use all political and legal tools at its disposal to ensure that national plans are fully consistent with Kyoto commitments and the verified data, so that there is a scarcity on the market and a level playing field for all participants. It has stated its intention to use actual, verified emissions from 2005 as a starting point for assessing member states' national allocation plans. That will mean more significant cuts from the Majority of other member states. That makes the point that the noble Baroness asked about: we have information from phase 1. We did not have it before we started. So we are moving forward.

The United Kingdom supports the messages from the Commission. We are actively lobbying to ensure that all member states set caps in line with the requirements of the directive to ensure real scarcity in the market. Ministerial calls are being made to Germany, France, Spain and Italy to build support across Europe for that leadership.

On the level of auction and the 7 per cent figure, a range of factors were listed in the consultation. I understand that, at the moment, there is no auction and the figure may move to 10 per cent. The figure of 7 per cent takes into consideration the 20 million tonnes of CO2 that we think are missing from phase 1. I have seen constant references to that. Those in the know, which I presume includes those on the two Opposition Front Benches, will understand that there is an issue about a missing 20 million tonnes. The consideration of the auction takes account of that.

The fund is a major opportunity. We will grasp the opportunity of the new fund to invest in renewable energy, non-nuclear low-carbon technologies and energy efficiency. There are a range of issues associated with that to deal with. Indeed, one of the Select Committees of your Lordships' House is undertaking an inquiry into biomass energy and use of fuel. So a lot of work is going on.

The question that the noble Baroness asked about aviation and transport is wholly legitimate. It is like the dog that did not bark. I understand that the Commission is due to adopt proposals to include aviation later this year. We hope that aviation can be included in phase 2 and we are considering extending that to other sectors in later phases and working with the Commission on that.

As I said, we are now in the second year of the first phase of the scheme. The results from year one have provided a first opportunity to judge allocations against emissions. As has been implied from what happened in the market earlier this year, it has been discovered that most member states' caps do not provide the scarcity that the scheme demands. The UK cap is 245 million tonnes and I understand that our system has worked quite well.

As for the environmental transformation fund using the proceeds from the auction, the decisions on the fund must be part of the normal process of public expenditure decision-making, as was mentioned in the Statement. The fact that we are auctioning 7 per cent of allowances will create receipts that will improve the expenditure context. That is new money designed to channel money into investment in renewables and low-carbon technologies.

If we use our brains and our innovation, we are on the cusp of helping to create in this country whole new industries in which we can almost repeat the Industrial Revolution in our offering to the rest of the world. We have an early start in many ways, and there are many examples from around the country of attempts at renewables, which, as I say, give us enormous potential.

New entrants will receive a level of allocation that incentivises the best available technologies. That is the only answer that I can give the noble Baroness. This is important; we want new entrants, but we want them to be incentivised. The whole scheme is a very low-cost way of introducing low-carbon technologies.

So far as future plans are concerned, the Commission is reviewing the directive and drafting a proposal to amend it, and we are already working with the Commission to ensure that lessons are learnt.

Finally, the noble Baroness asked about some of the older plants and how we will make inefficient plants close. Events will encourage investment in low-carbon technology. A stronger cap across all member states will stimulate demand in the carbon market and encourage investment in cleaner technology. The whole point of trading is that the Government do not decide which plant closes; businesses do. In other words, it is a commercial decision. That is the whole point. If we can build that in, we do not get political or non-market inference; we get something that makes people outside see that it is worth investing in change. That is the best way in which to bring about change. It is certainly preferred above all state direction. We must have a level playing field, which is why we have to work within the context of the EU.

My Lords, I welcome the Statement on this important subject and the Government's decision to set the cap at the top end of the range of effort on which they consulted. But the cost of carbon allowances, and therefore their impact, is driven, as the Statement pointed out, by the cumulative effect of all member states' decisions and the level of ambition of individual member states.

The review published this week by the Carbon Trust chief economist pointed out that if member states do not demand sufficiently large emissions reductions, the system will unravel and be ineffective. It is now clear that, during phase 1, there was considerable over-allowance by individual member states and by member states collectively. As the Statement put it,

"most member states' caps for phase 1 do not provide the scarcity the scheme demands".

It follows that cuts in allowances for phase 2 must not relate to those made in phase 1, but need to be assessed against a baseline of the recalculated 2005 emissions data that are now available.

The Minister said that the UK will expect more stringent caps to be enforced in phase 2, and will support the European Commission in its efforts to ensure tough caps. Good—I welcome that—but will the Government make every possible effort to ensure that the reductions are made from the revised data and not from the over-allowances for phase 1? I think the Minister began to indicate that that was the Government's position when he responded to a previous question, but I think it is the crucial issue on which the industry awaits an answer. Can he also assure me that the UK has given the lead by calculating our allowances on that basis?

My Lords, I hope I can give the noble Lord that assurance. I do not want to get into any "me, too-ism" about what other states are doing. There was some erroneous reporting early this week on the BBC. Obsessed as it is with seeking to undermine this Government, it is now seeking to undermine the German Government in its report stating that the Germans are going for only 0.6. Frankly, that is far from the truth, although I have not heard whether the BBC has apologised to the Germans.

The thrust of the noble Lord's question is such that I would want to say yes, because that is the way in which we want to go. We want to give the lead and genuinely to learn from phase 1. There is no doubt that in some ways we were on uncharted territory in phase 1 when we sought to introduce a market into this area. It was probably never going to be perfect in every member state. On the scarcity in the scheme, the Commission has stated that it will use all the political and legal weapons at its disposal. It said that in the Commission and in the important Financial Times article. We will use verified data emissions from 2005. We are taking a lead, which we are proud to take.

My Lords, I join the praise which the noble Lord, Lord Crickhowell, has given for this Statement, but, significantly, the United States is noticeable only for its absence from helping to resolve this issue. How are the Government and the European Union facing that issue?

My Lords, we are setting a good example to the rest of the planet.

My Lords, if the Emissions Trading Scheme is to be the cornerstone of Europe's drive, as the Minister put it in the Statement, is he satisfied that the political and legal tools available to the Commission are capable of reaching results which can be enforced when there is agreement between the member states? Would it not be appropriate to seek, before setting national targets, to have those discussions on what other nations are proposing to do, partly because of the competition consequences of not reaching agreed results?

My Lords, broadly speaking, I do not have any information indicating that there are not any political and legal tools missing. A paragraph in the Statement says that member states which have not done what they should will have to purchase credits from elsewhere, so that will cost them money. If they do not do that, they will have to pay a penalty. If I remember rightly from the briefing, the penalty was about 1.3 times the difference of what they should have done. That, I understand, is implied in what has already been agreed by the European Commission. From that point of view, the legal tools are in place. If they are not, I will write to the noble Lord.