This article looks at the key features of the government's proposals for a mandatory emissions trading scheme for large, non-energy-intensive organisations - the Carbon Reduction Commitment (CRC) - announced in the Energy White Paper published on 23 May 2007. The key organisations that are likely to be affected by the CRC are: large retailers and supermarkets, hotel chains, fitness centre chains, multiplex cinemas, mobile phone network operators, rail transport operators, large commercial laundry services, large office-based service organisations, light industry and manufacturing, government departments, hospitals, universities and local authorities.

Overview of Scheme

The CRC is the new name for the Energy Performance Commitment (EPC), which was the subject of a government consultation in 2006 and early 2007 (‘Consultation on measures to reduce carbon emissions in the large, non-energy-intensive business and private sectors').

A further consultation on the implementation of the CRC - ‘Consultation on implementation proposals for the Carbon Reduction Commitment (formerly the Energy Performance Commitment)' - was published in June 2007.

The CRC will target both direct CO2 energy use emissions and indirect CO2 emissions (ie from electricity) and is aimed at achieving government targets to reduce emissions from large non-energy-intensive organisations in the private and public sectors by 1.2m tonnes of carbon (MtC) per year by 2020. The government aims to begin the scheme in January 2010.

In order to minimise administrative and policy overlap, only energy-use emissions outside climate change agreements (CCAs) and the EU Emissions Trading Scheme (EU ETS) will be affected by the scheme. Organisations with more than 25% of their energy-use emissions in CCAs would also be exempt.

The CRC proposes an auction-based ‘cap-and-trade' system under which participants, having determined their own emissions targets, will be required to purchase allowances corresponding to their direct and indirect carbon emissions (either at auction or from each other) and then surrender them to a scheme administrator. Revenue raised through the auctions would be recycled to participants depending upon their performance in reducing emissions.

Under the cap-and-trade system, participants will have flexibility to decide how they comply, as with the EU ETS - either by reducing their own emissions or by purchasing more allowances that give them the right to emit.

Whilst the principal policy elements of the CRC would appear to have been settled, the government acknowledges that much of the detail relating to the implementation of the CRC remains to be finalised. The new consultation document therefore seeks views on the key outstanding issues. On the evidence of the workshop it staged in July 2007 at least, the Department for Environment, Food and Rural Affairs (Defra) seems genuinely keen to receive the input of likely participants in the scheme.

Which organisations would be covered by the CRC?

The government's proposal is that the CRC will cover ‘organisations' with mandatory half-hourly metered electricity consumption exceeding 6,000 megawatt-hours (MWh) per year. The aim of the 6,000MWh threshold is to target large, non-energy-intensive organisations in the private and public sectors, for which energy efficiency benefits will outweigh administrative costs. This threshold corresponds to an annual electricity bill of approximately £500,000. The government currently estimates that the scheme will cover about 5,000 organisations, accounting for around 14MtC annually.

The June 2007 consultation document substantially revisits the concept of an ‘organisation' for the purposes of the CRC. In place of the previous proposal that a CRC organisation would be the ‘entity to whom the half-hourly meters are registered' (which was considered unworkable), the proposal is now that whole company groups should participate in the CRC, with the highest UK parent organisation assuming compliance obligations on behalf of the group.

Accordingly, where a group has aggregate mandatory half-hourly metered electricity consumption exceeding 6,000MWh per year, all energy use emissions deriving from any fuel (eg electricity, gas and other fuels) at sites with metered electricity (including those of subsidiaries without mandatory half-hourly metering) will be caught by the scheme, although the consultation does leave the door open for the creation of a flexible de minimis threshold.

It seems that not all public sector bodies will fall within the remit of their respective government departments, as previously proposed. The consultation specifically highlights the case of the NHS, where either Strategic Health Authorities or Primary Care Trusts are likely to be the CRC participants rather than the Department of Health.

In general, while the new definition of organisation offers relative clarity for the private sector, the definition of a public sector ‘CRC organisation' still needs significant refinement.

The government had previously been considering allowing organisations falling below the 6,000MWh threshold to opt into the CRC, but has now ruled out this option.

Landlords and tenants

It is proposed that, where the tenant is paying the mandatory half-hourly metered electricity bill, this electricity will count towards the eligibility threshold for the highest UK parent organisation of the tenant. Where the landlord is paying it, however, this electricity will count towards the eligibility threshold for the highest UK parent organisation of the landlord.

In cases where the tenants do not pay the electricity bill directly and are part of a CRC organisation, and the landlord is also a CRC organisation, it is proposed that the legal obligation for CRC could be handed over from the highest UK parent of the landlord to the highest UK parent of the tenant if both tenant and landlord agree at the start of each phase.

Coverage threshold

Following feedback from the initial EPC consultation, the government decided to take a cautious approach and increase the electricity consumption threshold from 3,000MWh to 6,000MWh, a decision it justifies on the basis that administrative costs might outweigh energy efficiency benefits for those organisations using between 3,000MWh and 6,000MWh per year.

Miscellaneous participants

The government's preference is to include unmetered supplies (such as street lighting) in the CRC, but recognises the need to evaluate further the implications of the CRC for such supplies to ensure that the scheme effectively incentivises carbon savings. It also acknowledges that more thinking will be needed as to how to incorporate private sector contractors who provide street lighting services under Private Finance Initiative (PFI) contracts into the scheme.

As regards the rail sector, the government has decided that non-rail energy-use emissions (eg from stations, depots, etc) will be included, but is minded to exclude traction energy use, given its commitment in the Energy White Paper to exploring the potential inclusion of surface transport within the EU ETS. It is also concerned about the risk of modal shift away from rail to more carbon intensive forms of transport, which would cut across certain of its other policy objectives.

The government does not currently propose to mandate the inclusion of schools within local authorities' portfolios, since to do so would run counter to the general drive within education policy to devolve decision-making to school level.

Entry to and exit from the CRC

To minimise the administrative burden on organisations and the scheme regulators, organisations will not move in and out of the scheme on an annual basis, as a result of falling above or below the 6,000MWh inclusion threshold. Organisations' eligibility will only be reassessed prior to the commencement of each phase.

Key market design elements of the CRC

Scheme years

Scheme years will run from January to December and will be followed by a three-month reconciliation period, during which organisations collate their data, buy and sell allowances on the secondary market, report their emissions figures to government and surrender emissions allowances.

Introductory phase

The CRC will feature an introductory phase, likely to last for three years, to help participants become familiar with the scheme. This phase will also assist government in measuring the emissions profile of the sector, enabling it to ensure that the cap it sets for the initial capped phase is appropriate.

During the introductory phase, the price of allowances will be fixed. The government has indicated that it may link the fixed price to the average cost associated with a tonne of CO2 emissions under the climate change levy (approximately £8/tonne of CO2). Moreover, no limit will be placed on the total number of allowances available for purchase by participants for the duration of the introductory period. In all other respects (revenue recycling, performance league table, monitoring and reporting), the introductory phase will be identical to the capped phases which follow.

Capped phases

It is currently proposed that the first capped phase will start in January 2013 and that each of the capped phases will last for five years. This is intended to align the CRC with Phase III (and subsequent phases) of the EU ETS. This will of course depend on the EU ETS phase length continuing to be five years.

Caps for the phases from 2013 will be set by government on the advice of the Committee on Climate Change (the establishment of which was proposed in the recent Climate Change Bill). The government acknowledges that a delicate balance will need to be struck between setting caps early to provide participants with certainty and setting caps later with the benefit of greater knowledge of emissions results. It anticipates that the cap for the first capped phase will be set in 2012, once the results from the second year of the introductory phase are known.

Auctioning

During the capped phases, allowances will be distributed to participants by auction, which will avoid the time-consuming and political allocation processes familiar to participants in the EU ETS. Auctioning also allows participants to define their own emissions reductions targets, balancing their allowance needs against the cost of emissions abatement for their organisation.

The consultation outlines two alternative auctioning methods on which it seeks stakeholders' opinions: a ‘sealed bid, uniform price' auction or a dynamic, ‘ascending clock' auction. The former is simpler, but the latter allows a more efficient outcome. The public sector in particular has raised concerns about auctioning, specifically relating to the need to recruit additional personnel with particular financial skills to manage the whole process.

Secondary market

Once allowances have been purchased in the initial sale or auction, participants will be able to trade in the secondary market, should they wish to buy or sell surplus allowances. Active use of the secondary market by participants should help ensure that abatement is achieved cost-effectively.

Banking and borrowing

Banking of allowances will be allowed between capped phases but not between the introductory phase and the first capped phase. Organisations will not be allowed to ‘borrow' allowances from future years either.

Safety valve

The CRC will also feature a ‘safety valve' to prevent allowance prices from rising too high. This will consist of a ‘buy-only' link to the EU ETS, modified by a minimum floor price to prevent cheap EU ETS allowances flooding the market in the event of a crash in their prices There will be no link between the CRC and the current CCA market.

Other issues

Revenue recycling and the performance league table

The scheme will be broadly revenue neutral to the Exchequer. Auction revenue will be recycled to participants by means of a simple, direct annual payment, with a bonus or penalty depending on an organisation's position in a performance league table.

At the end of the annual reconciliation and reporting period, the government will publish a league table which ranks participants on their respective ‘performance' within the scheme and awards a bonus or penalty of 10% based on an organisation's position in the table.

Participants will be ranked according to a metric based on absolute emissions reductions, although additional metrics could be included to increase fairness. The two proposed in the consultation are an ‘early action' metric to reward those who took early action before the start of the scheme (likely to be measured by the uptake of automatic metering above and beyond legal minimum) and a ‘growth' metric to ensure that expanding organisations are not unduly penalised despite reducing emissions per unit of turnover. The government is in favour of including both these additional metrics and its preliminary suggestion is to weight them on a 60%: 20%: 20% basis.

Monitoring, reporting and audit

The monitoring and reporting aspects of the scheme are designed to be ‘light-touch', with no need for independent third-party verification as in the EU ETS. Reporting will be web-based, through an online registry, with a number of organisations each year selected for audit by the scheme regulators (initially 20% but likely to reduce as confidence grows).

Credit for renewables and combined heat and power (CHP)

The consultation proposes that ‘green' energy sources would be encouraged through reduced emissions ratings. On-site renewables would be zero-rated. Good quality CHP and other fossil-fuelled micro-generation technologies would also benefit, provided they have lower carbon intensity than grid-derived electricity. However, as in the EU ETS and CCAs, grid-imported ‘green' electricity would be treated like other grid electricity. Despite such provisions, there remains concern in the CHP sector that the carbon reduction benefits of CHP will not be fully recognised.

Enforcement, offences and penalties

Despite (or perhaps because) it has been designed as a ‘light-touch' scheme, the CRC will require strong penalties to deter abuse and secure compliance and principal offences are likely to include failure to participate, the supply of false or misleading information, failure to supply data and failure to surrender sufficient allowances.

Conclusions

A mandatory CRC system will now definitely be introduced for large, non-energy-intensive organisations.

Essentially, for private and public sector organisations with electricity consumption over 6,000MWh per year, the current proposals for the CRC are likely to relate to energy usage at properties such as offices, stations, depots etc and are not at this stage intended to cover mobile fleet.

Many issues remain to be resolved, however, and the government has wholeheartedly embraced the public consultation process with this scheme, in the hope that the various public and private sector consultees can assist in designing a light-touch, user-friendly scheme. Issues on which further thought will be required include the definition of a public sector organisation and how best to integrate PFI contracts into the scheme, a particular concern of the public sector being that private sector contractors are currently neither incentivised to reduce energy bills nor to build more energy-efficient buildings.

Despite the government's intention to recycle the revenue raised by the initial and subsequent auctions to participants, organisations may be left with substantial upfront costs when joining the scheme. A key further concern will also be that organisations which have already made emissions savings, or even gone carbon neutral, may well end up at a material disadvantage as they will potentially miss out on the benefits of revenue recycling through the CRC scheme.

The potential environmental benefits and stability of the system will, however, very much depend on the setting of a tight emissions cap as well as strong enforcement. This has not been achieved during phase one of the EU ETS, where there has been over-supply of allowances, leading to a substantial drop in the price of allowances to nearly zero.

As for the potential future developments, the government has already indicated that it may consider rationalising emissions regulation still further, potentially by consolidating the CRC and climate change agreements.