Fixing a hole where the CO2 gets out

The latest proposals for the UK’s pioneering Carbon Reduction Commitment will transform emissions policy for large energy users. Paul Hatchwell looks at the CRC’s key issues and prospects

Water pipes, courtesy of Water UKThe Carbon Reduction Commitment (CRC), set to launch in April 2010, will give the UK a world lead with the first mandatory carbon-cutting cap-and-trade scheme covering both public and private sectors of the economy.

The pioneering scheme, now in its third consultation stage, has been devised to ensure these sectors help the UK meet the emission reductions required by its new five-year carbon budgets. These establish a path for cutting greenhouse gas emissions by 80% relative to their 1990 level by 2050. It will help plug the gaps in UK climate policy outside heavily regulated power generation and energy intensive manufacturing industries.

The CRC arose from a review of the UK Climate Change Programme by the Carbon Trust in 2005, which noted the EU emissions trading scheme (EU ETS) and sectoral climate change agreements (CCAs) were focused on high-intensity energy users. Even the Climate Change Levy energy tax failed to restrain rising emissions from large, less energy-intensive organisations where energy costs were a low priority, but which still accounted for some 10% of total UK carbon dioxide emissions.

The latest CRC impact assessment by the energy and climate change department (DECC) estimates targeted bodies emit 53.2 million tonnes of CO2 per year. Even with available energy efficiency measures, cost-effective emissions savings could amount to some 1.5Mt of CO2 per year by 2015 and 4MtCO2/year by 2020.

The energy white paper of 2007 noted that business-as-usual commercial emissions alone were projected to rise by 17% between 2007 and 2025. It called for action based on a UK “consumption-based emissions trading scheme” suggested by the Carbon Trust report, covering direct and electricity-related emissions. This report also concluded that inadequate energy metering was preventing better energy management.

The government announced it would proceed with the CRC scheme in the 2007 energy white paper. But creation of the scheme and obligations on suppliers had to await primary legislation in the form of the Climate Change Act 2008. Crucially, this enabled secondary legislation covering creation of new emissions trading schemes and obligations on energy suppliers to deliver more detailed billing information to customers.

Where the EU ETS does not reach

The CRC will extend mandatory emission reductions and trading into a big part of the UK economy not covered by the EU ETS, which itself embraces some 40% of the nation’s greenhouse gas emissions. The new scheme will play a key part in bringing these non-EU ETS emissions under control.

Yet everyone buying power off the national grid, including organisations covered by the CRC, will find electricity prices gradually pushed higher by the EU ETS as its emission cap shrinks and more and more allowances are auctioned. The CRC therefore places a second layer of carbon pricing on those organisations it covers. DECC concedes this is not ideal, but says the EU ETS on its own is not up to the job of delivering the necessary UK carbon savings.

Breakdown of probable CRC participants by sectorMechanical engineering firms form the largest group of organisations to come under the CRC. But in the private sector, major retailers, banks, commercial landlords and water, plastics, chemicals and logistics firms are well represented. In the public sector, schools, hospitals, big local councils and government departments are all covered. So is the scheme’s own lead administrator and regulator, the Environment Agency (see figure 1).

The biggest emitter is the water sector, a heavy electricity user responsible for some 5Mt of CO2 equivalent a year, of which only 5% is directly covered by the EU ETS. Water UK’s climate change policy adviser Bruce Horton estimates a typical large water firm emits 500,000tCO2/year. But he stresses the industry is well ahead of the game, having developed a carbon accounting tool.

The CRC aims to drive energy efficiency improvements in large services and manufacturing organisations that are not energy-intensive but use large amounts of electricity and gas overall. It requires them to monitor and report all fixed-point electrical and other energy usage and to cut the associated CO2 emissions.

They must buy allowances to cover these emissions. The money spent will be recycled to them based on performance criteria. In short, if they do well, compared with their peers, in saving energy and cutting emissions they will get back more than they put in. If they do badly, they will get less back.

The current CRC proposals capture organisations if they have at least one half-hourly meter settled on the half-hourly market and use more than 6,000 megawatt hours of electricity across all of these types of meters in the qualification year (2008), excluding transport use. That implies an electricity bill above £360,000 a year.

Earlier proposals suggested a 3,000MWh threshold, but DECC dropped this to avoid disproportionately high administrative costs. Even so, those firms above this lower threshold but outside the CRC must report on electricity use through half hourly meters for each phase of the CRC, and may be included in future. Below this a simple declaration is required.

Under the spotlight

Countdown to the Carbon Reduction Commitment: timescale and phasesThe scheme will eventually set an emissions cap – a maximum annual level for all participating organisations – which will fall annually. Each organisation will have to buy enough carbon allowances through auction to cover its own emissions. But auctions and caps will not happen until 2013 (see figure 3). In its introductory phase starting next year, participants are allowed to buy an unlimited number of allowances at £12 per tonne of CO2.

Most stakeholders agree with DECC that the greatest benefits of the CRC will come from the ‘spotlight effect’. Simply obliging organisations that have not traditionally prioritised energy efficiency to assess and report their detailed energy usage could lead to major savings as waste and energy-efficiency investment opportunities are revealed.

Even so, serious concerns exist about the collection of this data. It is proving a huge challenge for the scheme’s administrator, the Environment Agency, and for organisations that have not done this before, either voluntarily or under the EU ETS.

The data from electricity suppliers needed to identify potential CRC participants among service sector customers with half-hourly meters was held back pending legal changes and confidentiality concerns. This finally changed when the Climate Change Act 2008 came into force, which placed a duty on suppliers to share the information.

The agency is starting to send initial information to billing addresses it judges likely to be affected by the CRC, with packs for qualification based on 2008 electricity usage to follow in September. It is also holding awareness-raising workshops.

Ahead of definitive data from registration, DECC and the agency are working with earlier estimates that some 5,000 organisations will actually fall under the CRC while 15,000-20,000 are expected to have to disclose information on energy use.

On 1 April 2010 the agency will take over the lead role of administering the CRC from DECC. The core CRC team is likely to expand to nearer to 30, with many of these probably working as contractors. It is already holding regional events and took over the helpdesk from DECC on 1 April this year.

By April 2010 the agency must establish and maintain a detailed registry of CRC participants to hold their ‘footprint’ reports and manage registry accounts, allowances and annual publication of league tables. It must also account for business ‘churn’ that can lead to changed company structures and baseline adjustments.

Integrating all of these elements is a logistical challenge. Orders were placed in March 2009 for a £3.4m IT system that will be central to these functions. It is expected to go live in January 2010. Support for carbon allowance trading will also be needed in 2011.

The CRC is intended as a ‘light touch’ scheme compared with the EU ETS, with evidence packs backed by a “risk-based audit ap­proach” covering 20% of participant submissions. This auditing will still require a major effort from the Environment Agency or third party auditors. It could offer big market opportunities for consultancies (see p 16).

Low awareness of CRC duties among firms and public sector organisations remains a concern. Many of those that are aware are still in the early stages of gathering data. Few organisations are believed to have set up centralised responsibility for monitoring and reporting energy usage, paying for CO2 allowances or receiving recycling payments – yet this will be essential for complying with the scheme. At present, monitoring energy use and paying fuel bills is often devolved to local cost centres.

Small beer

Companies will inevitably grumble about the extra bureaucracy and administration, but one of DECC’s key claims about the CRC is that it will save firms money by making them focus on cost-effective energy savings they are now missing.

It is estimated that the CRC will cost firms £0.43 per tonne of CO2 covered to administer each year. This implies it will cost the average organisation a few thousand pounds or at most hundreds of thousands a year. That is small beer compared with annual administration costs for EU ETS participants, estimated at £4.79/tCO2.

Emma Wild, principal policy adviser on climate change at the Confederation of British Industry, says “there is a significant administrative cost besides buying allowances”, including training and consultancy. Even so, she adds that businesses can stand to gain considerably from efficiency savings.

At £12/tCO2 the initial costs of buying allowances will cost participants from around £40,000 to tens of millions per annum. Even though this money is recycled back to them later, these payments will affect their cash flow. Under earlier CRC proposals, they would have had to wait an “extremely unreasonable” – according to the CBI – 18 months to get the recycled revenues. That has now been cut to six months.

Many consultees believe the consultation documents for the CRC are too long and complex for most firms. Yet that reflects the unavoidable complexity of the scheme itself. In its defence, DECC has also produced a fairly short, clear CRC users guide.

Emissions included in the CRCAn earlier consultation resolved concerns about overlap between the EU ETS, CCAs and the CRC (see figure 2). But issues remain about the incremental administrative burden of overlap, including reporting, for those already in the EU ETS or CCAs, and the new burden for previously unregulated bodies.

The chances of a single site being covered by all three schemes is low, but a conglomerate with multiple subsidiaries could find itself regulated under all three, as only those subsidiaries with 25% or more of emissions covered by CCAs would be exempted.

Establishing exemptions

Many groups are unaware they would still need to establish their eligibility for CCA exemption by submitting an evidence pack of data gathered throughout the company structure in the ‘footprint year’, which runs from April 2010 to March 2011. Full CRC exemption is only proposed thereafter if non-CCA residual energy use amounts to no more than 1,000 megawatt hours.

Even so, the Environment Agency thinks CRC footprinting would not be a big burden for such organisations, because they already collect detailed energy data for CCA compliance. Proposed synchronisation of reporting dates between CCA schemes and the CRC would simplify this task.

There are other issues causing concern, particularly the annual league table that will rank the carbon-reduction performance of all bodies covered by the CRC. Energy costs typically account for just 1-2% of the total costs of organisations covered; the hope is that fears of coming low in the league table will make them take energy efficiency more seriously.

But there are uncertainties about the form the tables will take and how they will be interpreted. An organisation’s position in the table will determine how much of the money it spent on allowances will be returned, with bonuses for high achievers and penalties for laggards.

Three measures, or metrics, have been devised to determine an organisation’s ranking: percentage change in CO2 emissions; carbon intensity of any growth or decline in turnover; and ‘early action’ in advance of the CRC. They have different weights which will change – the early action metric disappears after three years.

Tom Bainbridge, head of climate change and energy at law firm Nabarro, says the CRC is already boosting energy use awareness. But he believes the CRC’s greatest weakness is “the difficulty of predicting CRC outcomes” for an investment. The key concerns are not looking bad in the league table and not losing recycling ­payments.

Mr Bainbridge concludes that “those performing worst [now] are likely to do best out of this”. Late starters can, at least for the CRC’s first few years, fall back on low-cost energy-saving solutions  already implemented by more efficient organisations.

It is a point made by several critics of the scheme. But the counter-argument from DECC and others is that a firm can save far more by making cost-effective energy savings as soon as possible than it could ever achieve by delaying such measures and trying to reap the benefits later through the CRC. That is true, but it does not address the issue of high league table positions being easy to achieve for late starters.

In any case, the first CRC league table, due in October 2011, will use the so-called early action metric. But this is based on very limited criteria. Some sectors that have already invested extensively in energy savings and in renewables, such as the water sector, complain they receive no credit for this.

Another issue for several firms, particularly more energy-intensive companies that have enjoyed rapid growth, is the relative weighting of the ‘growth metric’ that credits low-carbon intensity growth in turnover compared with the ‘absolute metric’, based on simple percentage reduction in an organisation’s emissions. The absolute metric will carry three times the weight of the growth metric in determining league table position; some firms ambitious for growth argue that this is too much.

Perhaps the biggest uncertainty surrounding the CRC is how the firms and public sector organisations it covers will take to trading carbon allowances among themselves or with third parties. If they find themselves with insufficient allowances to cover their emissions, they will have to cover the shortfall through purchases.

Once the CRC becomes a fully fledged cap-and-trade scheme in 2013, previous allowances will be cancelled and a reducing number will be auctioned each year. Participants may bank these for future use, encouraging a secondary market. Predicting energy use and managing carbon will become increasingly important.

Stability concerns

There are concerns about the stability of allowance prices. Most expect trading to be slow at first, especially during the introductory phase, dominated by last-minute compliance needs and offloading of surpluses rather than sophisticated trading strategies. This would risk price ‘spikes’.

However, a ‘safety-valve’ mechanism should reduce this risk. It would allows organisations facing high CRC allowance prices on the secondary market the alternative of buying EU ETS emission allowances through the agency – these would then be delivered as CRC allowances. This procedure involves an upfront deposit plus paying VAT and administration costs, so it is considered an option of last resort. A floor price of £12/tCO2 also protects the integrity of the scheme against EUA price collapse.

The Environment Agency wants organisations to think about spending money to cut energy use and emissions in order to avoid spending even more money on buying emissions allowances. It will prepare guidance on the mechanics of trading, but trading strategies are left to organisations to devise.

Despite teething problems, there is widespread support or at least acceptance of the need for the CRC, and its role is likely to expand in the future. DECC sees potential in a lower electricity consumption threshold to bring more bodies under the CRC, but this will depend on review after the scheme’s launch to ensure this would be “cost-effective and proportionate”. For its initial phase, DECC is erring on the side of caution.

David Kennedy, chief executive of the government’s advisory Committee on Climate Change, told ENDS that the CRC is a crucial first step in bringing those parts of the economy outside the EU ETS within new carbon budgets.
However, amid concerns that the CRC does nothing to encourage electricity generation from renewable sources (see p 17), he said the committee would look in detail over the next month into how the CRC could run “in a way that would promote increased renewables and heat [efficiency]”.

In the coming months, the committee will be making important recommendations on the future development of the CRC, including the size of its emissions cap beyond 2013. Much is riding on the success of the crucial first few years.

The Carbon Reduction Commitment

A special report, sponsored by RPS(energy and environmental consultants)