UK Carbon Reduction Commitment explained

What is the cap and trade scheme all about?


The Carbon Reduction Commitment will bring in the UK’s first mandatory carbon trading scheme, starting in January 2010. Although 2010 may seem a long way away, 2008 is the qualifying year for participation in the scheme.

It will cover large non-energy intensive business and public sector organisations. About 5000 organisations will come within scope of the new legislation, ranging from retailers, banks, water companies, hotel chains, universities and local authorities.

The scheme is compulsory for large organisations using more than 6,000 MWh/year of half-hourly metered electricity, which translates to roughly £500,000 in electricity bills, and is aimed at encouraging these large organisations to reduce their fixed source energy consumption.

Companies will have to start buying carbon allowances to cover their carbon emissions, and that will involve measuring and recording energy use and calculating carbon dioxide (CO₂) emissions (not including transport emissions).

The revenue generated from carbon auctions will be redistributed between the scheme’s participants. Each company will receive a larger or smaller amount than they originally paid for their carbon allowance, according to their performance in the CRC league table.


What is the CRC league table?


The main driver for the CRC is to stimulate energy efficiency in organisations, which might otherwise be resistant to implementing energy efficiency measures. A league table may affect brand reputation and therefore has a good chance of grabbing management’s attention.

The CRC league table will be published each year after companies have reported their annual carbon emissions. CRC participants will be awarded bonus or penalty payments according to their placement in the league. In the first year the repayment adjustments will be between +10 and -10 percent. This will widen significantly to +50 and -50 percent by year five.

The league table will be based on three metrics - an absolute metric, a growth metric, and an early action metric – to gauge the energy saving achievements of companies (see "What are the metrics" below).


How much will it cost to take part in the CRC?


The first auction is due in April 2011, when bidders will be able to buy allowances to cover their 2010 emissions as well as for forecast 2011 emissions.

Subsequent auctions will only apply to the year immediately ahead. An allowance will need to be purchased for every tonne of CO₂ emitted in the year.

The government has indicated that the price of CO₂ is likely to be set initially at £12 per tonne. Using DEFRA’s average electricity / carbon conversion factor (0.523 kg CO₂/kWh), the threshold qualification of 6,000 MWh of electricity translates into mandatory carbon credits purchases of about £38,000. If the organisation uses more than the qualification threshold level, the cash outgoing will be more.

Given the cash flow implications of CRC, it is essential for those organisations coming within scope to prepare and budget for CRC compliance.

Proper data management systems and accurate carbon assessments will be critical to CRC compliance as there will be penalties for under-reporting emissions. Penalties for under-reporting are expected to rise to £75 per tonne CO₂ from 2013 onwards.


Can we avoid being in the scheme?


Usage of electricity may become transparent to the regulator (as energy suppliers already have the data) and so it is unlikely that any organisations that should have qualified but did not register will go undetected.

However, since qualification for the CRC is based on metered electricity in 2008, it may still be possible for organisations on the borderline to reduce their electricity consumption through energy efficiency to come in just under the 6,000 MWh threshold.

Companies using just under 6,000 MWh, will have to prove it by putting together an “evidence pack”, which includes details of the organisation (contact names etc), electricity and fuel bills, automatic metering records, procedures used to collect data and check correctness, and information about special events, such as changes to energy suppliers and organisational subsidiaries.

During 2008 organisations are expected to identify whether they qualify and the deadline to notify the government is in early 2009. In the same timeframe, the Environment Agency, who will administer the CRC, will contact all UK billing addresses with half hourly meters providing them with Registration Packs.


Will green energy tariffs be counted as zero carbon?


To the frustration of companies investing in renewable energy sources, green electricity does not count as zero carbon under the CRC and so it is not possible to avoid qualification for CRC by changing the way in which the organisation procures electricity through the grid.

This rule exists because upstream, the licensed electricity suppliers have already been incentivised to pursue renewable energy sources through the use of tradeable Renewable Obligation Certificates (or ROCs) – renewable energy subsidies that are essentially funded by UK energy users.

Non-ROC funded renewable energy will however be counted as a zero carbon source under the CRC - see Ethical Corporation's CRC report for more details.


How can companies best benefit from the CRC? What strategy will earn us money?


The best way to benefit from participation in the scheme is to deliver what the scheme is designed to achieve: reduction in CO₂ emissions. By acting early, implementing energy efficiency measures and reducing CO₂ emissions an organisation has the best chance of capitalising on the potential benefits.

A company can benefit by:

- Reducing its energy bills.
- Earning profit by being placed in the upper part of the CRC league table.
- Acquiring prestige and positive media attention by having done well.

The opposites apply for businesses, which do not do well under the CRC and find themselves lower down the league table.

Although revenue from the carbon auctions will be recycled, participants will notice a significant impact on cash flow at the start of the scheme. The baseline year for revenue recycling in the first phase is to be calculated on six months of data, corresponding to the period October 2009 and March 2010.

Sales of allowances will take place each April and participants will have to report on emissions. The money generated from the auctions (less the administration costs of running the scheme) will be recycled to the participants. The gap between auctioning and revenue recycling is six months.

The price of carbon may rise in subsequent years, especially as allowances for emissions are restricted. The best way to counter the uncertainties in the price of carbon is to invest in energy saving measures and to reduce energy usage. The organisation will then benefit from reduced energy bills and reduced costs of participation in CRC. A company may subsequently drop out of the CRC if it falls below the threshold level.

However, to realise the savings the organisation will need to ensure that it has the right skills to implement the required energy saving measures, and to invest and trade in emissions allowances.


What are the metrics for the CRC league table?


From 2011 the government will publish a league table of carbon performance of organisations, or at least name and shame those organisations at the bottom of the table. There is the potential therefore for the reputation and brand of the organisation to be affected. Participants will receive a score for each of the three metrics and these will be combined to give an overall score. This will determine where a participant is placed in the overall league table.



How to manage carbon reduction, and make it pay: A concise and comprehensive introduction to the Carbon Reduction Commitment.



The absolute metric is the base metric on which the league table will be formulated and will be the percentage change of annual emissions relative to the organisation’s previous five year rolling average. This will account for a 60% weighting in the league table during the introductory phase.

The growth metric will measure the organisation’s percentage change in emissions per unit of turnover relative to its average emissions per unit of turnover. For the public sector it will be per unit of revenue expenditure rather than unit of turnover. This will account for a 20% weighting in the league table for the introductory phase.

The early action metric will be in two parts. The first part is the extent that an organisation has installed non-mandatory automatic, or ‘smart’ metering. This will be measured as the percentage of an organisation’s emissions covered by non-mandatory automatic metering. The second part of the early action metric will be the percentage of an organisation’s emissions covered by the Carbon Trust’s Energy Efficiency Accreditation Scheme (EEAS) or new Carbon Trust Standard (CTS).

The two parts of the early action metric will carry equal weighting (50/50) and account for a 20% weighting in the league table. The metering part of the early action metric will be frozen after the first year of the scheme and the entire early action metric will be discontinued after the introductory phase.


Will our facilities manager have to become an energy efficiency specialist?


Implementation of the CRC will affect a wide variety of job functions. Energy usage and carbon management activities are often spread across an organisation, from facilities management, operations, logistics, procurement, regulatory affairs, procurement, finance, treasury, environmental, production, CSR, H&S, sustainability, and training, to name but a few. The CRC compliance team is likely to interact across all these functions. It would be a mistake to think that CRC compliance should be delivered soley by the facilities manager. The task is too broad for one person.

Participation in the CRC will require expertise in investment and trade in financial instruments for emissions. In Phase 1 of the CRC (from April 2010 to March 2013) participants in the scheme will need to purchase an allowance for every tonne of CO₂ emitted in the year.

In Phase 2 (from April 2013 onwards), the number of available allowances will be capped by the government and the purchase price will be unknown until a sealed bid auction is complete. Because there will be a cap on emissions, it is likely that a secondary spot market will emerge through which participants can sell and purchase excess allowances.

Engaging in auctions and secondary markets for carbon emissions is likely to be new for many organisations and this will highlight a skills gap that needs to be addressed.

Organisations can choose to either do some or all of these things internally or outsource some of them to CRC third parties, such as carbon traders specialising in handling the CRC allowance portfolios for client businesses.

Some businesses may establish their own teams of carbon traders. Being in a position to at least assemble the evidence pack internally is likely to be cost effective, especially as the organisation evolves its carbon reduction programmes. At the end of the year the organisation will have to calculate its total emissions and submit an evidence pack containing detailed energy records to the government.


What’s on the CRC horizon and what should the business be doing?


As we approach the end of the qualification year, it is worth reviewing the evidence pack, making sure that all the operational units and departments which should be represented are included. Are there any gaps in the invoices and has the organisation reviewed its CRC cash flow and tax implications? In time the organisation will have to trade carbon allowances. Have training budgets been allocated to ensure the skills will acquired on time?

DEFRA is currently working on the consultation paper for the draft regulations and aims to publish it in early 2009. That will be a good opportunity for companies to assess the proposed regulations and clarify in detail the implications for the business, both from a strategic perspective and more detailed management and operational perspectives.

By summer 2009 organisations will have been required to submit their energy use data to the regulator and declared their inclusion (or otherwise) in the scheme. Those with Climate Change Agreements (an industry specific carbon reduction agreement previously agreed with DEFRA) will also need to submit their energy use data to support petition for exemption.

From September 2009 onwards, participants in CRC will set up their registry accounts for the start of the scheme in January 2010. At that point it will be all systems go as participants purchase allowances and begin monitoring and measuring emissions.

After that there is a complex timeline of energy and emissions measuring, reporting, notifications to the regulator, announcements of emission caps, and submissions of energy use data.

As the introductory phase of the scheme gives way to the first capped phase in 2013, the way in which many businesses manage their energy systems will have changed significantly. Procedures and processes, management and operational systems, human resource skills and organisational capabilities will need to be built up to respond to and benefit from these developments. That means that management must get to grips with CRC now, if it has not already done so.


We’ve already done the low hanging fruit. What’s next?


If a company finds itself within scope of the CRC and has already achieved energy savings from the low-cost easy-to-do measures (eg changing to energy efficient lighting, switching off appliances when not in use), it is well worth looking at the bigger picture for carbon reduction.

It may be appropriate to implement major infrastructure changes, such as on-site energy generation systems and green data centre technologies as well as examining scope for energy savings through systems integration and intelligent control systems, depending on the business context and how the financials stack up.

Eco-designing goods and services by using less materials may also help to reduce emissions as well as manufacturing costs. Product ecodesign can provide the next crop of low hanging fruit, and another tranche of cost savings.


CRC and reputational price


Given the strategic implications for the business, management should be familiar with CRC and the implications of it for the organisation. Each April (except in year 2 which requires retrospective purchase of allowances) the organisation will need to set an emissions target in order to purchase allowances to cover the expected CO₂ emissions for the year ahead. Management will need to give approval for purchasing CRC allowances. CRC carries not only an energy price but also a reputational price. It is well worth getting it right.



Dr Michael Gell is Managing Director of Xanfeon Energy & Environmental Services
(www.xanfeon.co.uk) and can be contacted on +44 (0)1493 446552 or
mgell@xanfeon.co.uk