The Carbon Reduction Commitment (CRC): Under fire already

The Carbon Reduction Commitment (CRC): Under fire already

The CBI has criticised the CRC in its recent report “Back to the Answer: Making the CRC Work”, saying that the changes made in the October 2010 spending review, whereby the payments from the CRC would no longer be recycled, means that the system no longer encourages companies to reduce emissions. In fact, the scheme now merely acts as a tax on business, making the cost of doing business in the UK more expensive and restricting the economic recovery.

The CBI said that instead of the CRC in its current form, the Government should scrap the scheme and move to a full cap-and-trade system. Alternatively, the CBI suggested that the CRC be merged with the Climate Change Levy (CCL), using CCA credits to obtain the energy efficiency goals under the CRC. CRC+CCL+CCL. What the &*#@! Below we explain (through republishing old blogs) what each of these are and how they work…

The Carbon Reduction Commitment:

What is it?

The Carbon Reduction Commitment (CRC) is UK legislation deriving from the Climate Change Act (2008) that covers C02 emissions not already covered by the ‘EU Energy Trading Scheme’ and ‘Climate Change Agreements’. The purpose of the CRC is to encourage energy efficiency in organisations so that the UK can meet environmental targets set out in the Climate Change Act. It aims to reduce C02 emissions in large non-energy intensive organisations by 1.2m tonnes of carbon per year by 2020 and will affect some 20,000 public and private organisations in the UK, with some 5,000 organisations having to participate fully (the other 15,000 will have to make information disclosures only under the scheme). The CRC is a mandatory scheme that places legal obligations on organisations with financial penalties for failure to comply.

How does it work?

The CRC is a ‘cap-and-trade’ emissions trading scheme that will effectively put a market price on carbon emissions thereby providing a financial incentive for organisations to reduce emissions through energy efficiency. The relevant UK authority (the Environment Agency) will set the total limit of carbon emissions  for qualifying organisations allowed in a single year and auction off these emission allowances to qualifying organisations in July each year (the ‘cap’). Organisations that exceed their initial emissions allowances will then have to buy excess allowances from organisations that have spare ones available for sale (the ‘trade’). This is likely to lead to a secondary market for emission allowances once the scheme takes full effect. The UK Government will then reduce the total number of auction allowances each July by a pre-determined percentage, so as to reduce the total allowable carbon emissions by qualifying organisations. This will help the Government reach its climate change emission targets. The reduction in total carbon emissions permitted in preceding years is expected to be offset by investment by qualifying organisations in energy efficient strategies. The CRC has been designed so that any cost of implementation by participating organisations should be more than offset by the energy reduction strategies they use to reduce energy bills. For this reason the CRC is being implemented over a 3 phase period: the 1st Phase (The Introductory Phase) runs for 3 years, with 2 subsequent phases running for 7 years (with the first 2 years of these phases being preparatory, and overlapping with the previous phase).

[The revenues generated from the initial auction in each year will be recycled back into the market at the end of each year, with those showing the best improvements in carbon reduction receiving payments back from the Government plus a bonus. Those who underperform will also receive a payment from the Government minus a deduction for underperformance] This was scrapped in the October 2010 Spending Review. The Government will also publish a league table showing the ranked performance of each qualifying organisation which will be made public. This league table will decide whether the organisation receives a bonus or deduction when the Government refunds the auction revenues. Therefore, there is not only financial incentives from the Government for organisations to think about but also reputational incentives also

Who qualifies?

The qualification criteria for the Introductory first phase of the CRC is based solely on electricity consumption for 2008, and more specifically on Half Hourly Meter (HHM) readings. An organisation will qualify for inclusion into the CRC if:

The organisation had at least one half hourly electricity meter  (HHM) settled on the half hourly market across the whole organisation

The organisation had a total half hourly electricity consumption of at least 6,000 MWh

This implies that an organisation with an annual electricity bill of around £500k would qualify for the CRC and in total some 20,000 organisations will be affected in the UK. If your organisation had at least one HHM settled on the half-hourly market BUT total electricity consumption was less than 6,000 MWh for 2008, then you only have to make an information disclosure under the CRC (mandatory). Organisations with electricity consumption greater than 6,000 MWh will have to participate fully within the CRC (this is expected to be about 5,000 organisations in the UK). The exemptions to this are if the organisation falls under the jurisdiction of the EU ETS or the Climate Change Agreements (CCA’s).

When does it begin?

Registration for the CRC, and the legal requirements to do so, began in April 2010. However, the Introductory phase began in March 2008 and runs until March 2011 with subsequent phases running for 7 years. Each phase will consist of (dates in parenthesis are for the Introductory Phase):

Qualification Period (2008): Organisations assess whether they qualify for the CRC (whether to participate fully or to make an information disclosure)

Registration period (April 2010-Sept 2010): Organisations must either register for the CRC or submit information disclosures

Footprint Year (April 2010-March 2011): Organisations must monitor and report their total Carbon Emissions in a Footprint report.

Compliance Years (April 2010-March 2011): Organisations must purchase allowances and monitor emissions for a number of years.

Firstly, an organisation must see if they qualify for either full participation within the CRC or if they have to make an information disclosure (or neither). As mentioned above, this is solely based on 2008 electricity consumption and is available from your electricity suppliers. However, your organisational structure may affect this (please see other document). Once this is established you will then need to prepare to register, monitor emissions, produce your Footprint report and produce an annual report. These are mandatory and legally binding with financial and reputational ramifications for organisations.

Registration: This takes place between April 2010 and Sept 2010

Footprint Report: Whilst qualification for the CRC is solely based on 2008 electricity consumption, actual participation within the CRC requires you to consider ALL energy consumption to determine your C02 emissions (for which you will have to purchase allowances). Total footprint emissions are based on:

• Electricity
• Gas
• Any other fuel types such as coal etc

Annual Report: you must also produce an annual report of your actual carbon emissions for each year and submit this report, with the correct number of allowances based on ACTUAL emissions for the year.

Failure to Comply:

The most startling reaction here is that Directors of a company are liable for correct reporting of information, and failure to comply can result in a large fine and/or imprisonment for that Director!

More importantly are the implications for the brand of a non-compliant company and the reputational repercussions that may occur.

Here is a brief summary of penalties:

Climate Change Agreement’s (CCA):

These allow eligible energy intensive business users to receive up to an 80 per cent discount from the Climate Change Levy (CCL) in return for meeting energy efficiency and/or carbon saving targets. CCAs have a two-tier structure:

• a sector-level agreement between Defra and the sector or trade association (known as an umbrella agreement).
• an individual agreements between Defra and the operator of the facility (known as underlying agreements).

The umbrella agreements set out sector targets, the obligations on the sector and the Secretary of State, and the procedures for administering the agreements. The underlying agreements set out the targets to be met by the target unit, the obligations on the operator and the Secretary of State, and the procedures for administering the agreements. Climate Change Agreements (CCAs) cover a wide range of industrial sectors, from major energy intensive processes such as steel, chemicals and cement, to agricultural sectors, such as intensive pig and poultry rearing. Smaller sites that do not meet the size thresholds of the Pollution Prevention and Control (PPC) Regulations, but which otherwise would qualify, are also eligible for an agreement. The exception to this is combustion plants of greater than 50 MW capacity and the 3 MW limit for burning of waste oil, recovered oil or fuel manufactured from or comprising waste. On 12 March 2009 DECC launched a consultation on the form and content of new Climate Change Agreements following the Government’s decision to extend the scheme (subject to State aid approval), until 2017. The Government has reviewed the current Climate Change Agreements with a view to simplifying them for the benefit of business and government and to achieve greater coherence with other relevant climate change policy. It makes a number of proposals for changes to the form and content of existing Climate Change Agreements, on which the views of interested parties are sought. A number of questions are also raised about other possible changes to the Agreements on which the Government may decide to make proposals, subject to the nature of the responses it receives. A consultation period runs to 4 June 2009.

Climate Change Levy (CCL):

The CCL is an energy tax that adds approximately 15% to typical energy bills of UK businesses. The CCL is a key part of the UK governments strategy to promote energy efficiency and reduce greenhouse gas emissions. The CCL is applied to electricity, gas, coal and Liquid Petroleum Gas (LPG), but is not applied to any domestic supplies. The impact of the CCL upon UK businesses has been helped by a 0.3% reduction in National Insurance contributions. Energy intensive industries are able to join Climate Change Agreements to help further mitigate the effects of this tax. The levy is part of a range of measures designed to help the UK meet its legally binding commitment to reduce greenhouse gas emissions. It is chargeable on the industrial and commercial supply of taxable commodities for lighting, heating and power by consumers in the following sectors of business: industry, commerce, agriculture, public administration, other services. The levy does not apply to taxable commodities used by domestic consumers, or by charities for non-business use. In order to protect the competitiveness of energy intensive sectors subject to international competition, Climate Change Agreements (CCAs) were introduced alongside the levy which provide an 80% discount on the levy if challenging targets are agreed and met for improving energy efficiency or reducing greenhouse gas emissions. The package of measures introduced with the Climate Change Levy also included the Carbon Trust and the Government’s Enhanced Capital Allowances (ECAs) Scheme for investments in energy saving technologies and products.

A Guide to Cap and Trade:

This document sets out the theory and processes of Cap-and-Trade systems that are being adopted throughout the world. The cap-and-trade system was first implemented through the Kyoto protocol, and currently the largest system in operation is the European Union Energy Trading Scheme, known as the EU-ETS.

How does cap-and-trade work?

The regulator or originator of the scheme determines which emissions are to be monitored and then introduces a “cap” on the total amount of emissions allowed in any one year. The regulator must also consider who this cap applies to, and the cap is the sum of all emission allowed from all included facilities. Following this, the regulator issues emission permits (called allowances) to the companies included in the scheme. These emission allowances authorises the holder to emit a certain amount of the specified greenhouse gas, with the total number of allowances being equal to the level of the “cap”. At the end of the year, all companies involved must submit the correct number of allowances to the regulator for the preceding year (called the compliance year), with the correct number of allowances corresponding to the level of emissions they emitted. If a company has more allowances than they need (i.e. they emitted less than expected) they can sell these allowances to companies that have fewer allowances than they need. This facilitates the trading of allowances and sets a market efficient price for carbon emissions. Therefore companies that embrace energy efficient strategies, and renewable energy solutions can benefit by receiving cash for their allowances that they did not use. Similarly, companies that do not invest in energy efficiency are penalised as they have to spend extra costs on buying extra allowances. Putting a price on carbon allows emissions to be brought into the cost of production process for companies. Whilst allowing the market to determine the price of carbon allows an efficient and fair price to be set away from any regulatory body. The cap can then be reduced gradually to achieve the required reduction to emissions, whilst still allowing industry to gradually adjust to a low carbon world.

Another reason that allowance trading takes place is because the cost of emission reduction is different for different sectors. Thus a trading market for allowances, enables an economy to transfer these cost advantages for emission reductions to be transferred from one industry to another.

Cap-and-trade market design:

When designing a cap-and-trade system, the originators must consider the following:

-          What emissions will be covered?

In general the 7 Kyoto GHG should be included, although some systems will only consider carbon emissions. The main point is that you should only include emissions that are easy to monitor, measure and control, as otherwise the system will be too complex to regulate

-          Who is covered by the system?

Here the originators of the system must decide who will be required to participate in the scheme and purchase allowances etc. Some systems, such as the EU ETS, only include the largest polluters such as power generation and major fossil fuel consumers. However, the more participants that are included in the system, the greater the benefit of the system as economies of scale will influence the cost benefits from carbon savings/trading.

-          What level of “cap” should be placed on the emissions?

The level of the cap will obviously depend on the ambitions of the originators, and indeed it is intuitive to suggest the cap should be reduced to 0% as soon as possible. However, governments need to take into account the effects on industry and allow time for an economy to adjust to a low carbon world. Therefore gradual cap reductions are often preferred, although the race against climate change does mean there is a final deadline.

-          How should allowances be distributed?

There are 2 main methods of allowance distribution: allowance auctions or allowance allocation. Allowance allocation is whereby the regulator distributes allowances based on some form of measurement which can be anything from amount of emissions emitted in the last year, or tons of products manufactured. This allowance then decreases year by year, eventually weaning the company off carbon emissions. However, this does not encourage firms to go above and beyond what they could do to reduce emissions, and certainly does not reward them for being more energy efficient compared to industry peers.

The other method is to auction allowances, allowing those prepared to pay the most for them to receive them. The fact that companies would have to pay for emission allowances would encourage them to seek alternative energy sources, and incorporates the emission allowances into the cost analysis of the production process. The auction revenues also provide the regulator with income which can be used to further incentivise the corporate move to a low carbon society (by rewarding those that excel etc), and to invest in research and development of energy efficient products. However, auctioning is seen as being a large burden on industry and can effect competitiveness and effect the economy. For this reason most regulators are fazing in the auctioning process.

-          How to stop the cost of the program from being too detrimental to the economy?

There are several mechanisms that can be implemented to avoid the cost of the program becoming too detrimental to industry:

Offsets: when an emission reduction project is implemented outside of the cap-and-trade program, the regulators can allow the participants of the cap-and-trade system to buy the emission credits from the reduction programme to count towards compliance for the cap-and-trade system. Most systems allow this although they do stipulate that the carbon reduction offset must be viable, accredited and from a source that would otherwise not have happened except for the financing from the credit purchasing entity. This system is available in the EU ETS under the Clean Development Mechanism (CDM) as is seen as benefiting developing nations where a lot of these projects are undertaken.

Flexibility: Some systems allow participants to borrow or bank emissions from one year to another so that if you don’t use all allowances in year one, you can carry them over to year 2 etc. Similarly, if you need to use more allowances than you have you can borrow them from a future year under the premise that you will pay them back at some point in the future.

Safety Valves: This is a mechanism that triggers a change in the cap-and-trade program if the market price of carbon is seen as excessive or the system is seen as too stringent. The trigger may include the distribution of new, extra allowances, or a temporary relaxation of the compliance restrictions.

-          What is the cost of non-compliance?

Finally, an originator of a cap-and-trade system must decide how to penalise companies that do not comply with the system. This must be severe enough to ensure that the penalty is much greater than the benefits from cheating or non-compliance. However, one must ensure that the system is fair and takes into account market conditions and circumstances.

In summary:

The cap-and-trade system offers significant advantages over carbon taxes as it allows market forces to establish a market price for carbon, allowing emissions to be factored into the cost of production process. It also allows market forces to determine how best to move towards a low carbon economy, and enables research and development in the most cost-efficient emission reduction technologies.