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Mechanics of UK 2010 CRC Cap and Trade Scheme

Many thanks to Pavel for this. Key quotes:

Whilst many businesses have been aware that they will be affected by the Carbon Reduction Committment in some way until now the detailed structure of the Scheme has remained unclear. The CRC requires a step change for large organisations not subject to a cap and trade system previously

for some organisations, the scale of bonus/penalties within the recycling payments may provide insufficient incentive to change their energy use. However, they expect that ranking in the league table, and the subsequent associated positive or negative publicity will be a substantial driver.  

Hi JF - Hope all is well with you...I thought this was very interesting:

Consultation on the Draft Order to Implement the Carbon Reduction Commitment

On 12 March 2009, the Department for Energy and Climate Change ("DECC") launched a consultation on the draft Carbon Reduction Commitment Order 2010 (the "Draft Order"). The Draft Order introduces a mandatory cap and trade carbon-trading scheme for large non-energy intensive businesses and public sector organisations, known as the Carbon Reduction Commitment ("CRC" or the "Scheme"). The CRC is the first in a potential series of new trading schemes to be launched under the Climate Change Act 2008 (the "Act").  

The contents of the draft Order have been keenly anticipated for some time. Whilst many businesses have been aware that they will be affected by the CRC in some way until now the detailed structure of the Scheme has remained unclear. The CRC requires a step change for large organisations not subject to a cap and trade system previously. Obligations for participants are already underway, for example in relation to certain information collecting requirements. Businesses need to be alert to their obligations and the mechanics of the Scheme now and where appropriate use the opportunity to comment on the detail of the Scheme. The consultation is open until 4 June 2009.

Background and rationale

The legislative basis for the CRC is contained in the Act. However, proposals for the Scheme were first raised in the Energy White Paper published in May 2007. The carbon reduction targets underpinning the Scheme, contained in the Act, are set at a reduction of CO2 emissions of at least 80% by 2050, and at least 26% by 2020, against a 1990 baseline. Currently the Government estimates that large organisations not covered by other schemes contribute to about 10% of the UK's greenhouse gas emissions. The Scheme aims to deliver additional emissions savings of at least 4.4 tons of CO2. The Government estimates that this will result in a saving of £1 billion in energy bills.  

The basic obligations under the CRC are to report annual CO2 emissions to the Government at the end of each Scheme year and surrender an amount of 'emissions allowances' that are equivalent to the participants' CO2 emissions. This is called the 'performance obligation' under the Draft Order. However, there are a number of other obligations.

The need for allowances under the CRC will start in April 2010, although participants have monitoring and reporting obligations in advance of this date. The Environment Agency will be the UK-wide administrator of the scheme. The Environment Agency, the Scottish Environment Agency and the Northern Ireland Environment Agency will be responsible for regional regulation.  

Many organisations affected have not previously had any need to identify and measure their energy usage. The scrutiny focused on energy and necessarily efficiency will be a marked change and is intended to resonate across all organisations both within and not covered by the Scheme.  

Who is affected by the CRC?

Full participation is determined by electricity consumption

A person or an organisation will qualify for participation in the allowance surrender portion of the CRC if as at end of 2008 they had at least one electricity meter settled on the half hourly market and their total annual half-hourly metered electricity use for 2008 was greater than 6,000 MWh. This equates roughly to an annual electricity spend of around £1 million depending on tariff.

Importantly, all organisations that have half hourly billing will have some obligations under the Draft Order. All organisations with a half hourly electricity meter settled on the half hourly market will have to provide the Government with a list of their settled half hourly meters regardless of electricity consumption levels. Those organisations that have electricity consumption in excess of 6,000 MWh must participate the allowance surrender portion of the scheme. Organisations likely to be included within the Scheme include large businesses, retailers, banks, landlords, supermarkets, hotel chains, water companies, local authorities, universities and government departments. The Government estimates that initially some 4,000 to 5,000 organisations will be included within the Scheme. However, it is possible the Scheme will be extended to smaller organisations in the future.

If the electricity usage qualification is met, all fixed-point direct and indirect energy consumption must be used to calculate the participant's total energy use emissions (see further below). These emissions will then be reportable under the CRC.

Who is responsible for compliance with the Scheme?

The obligations under the CRC fall on the counterparty to the energy supply contract – i.e. the person or organisation that pays the electricity bill. It will target fixed-point emissions on an organisation-wide level rather than on a site-by-site basis. Emissions from transport are excluded.
Special rules determine how related organisations (i.e. subsidiaries and their parents) should participate in the Scheme. All organisations within a group will be deemed one participant. The highest UK parent organisation of the combined participant will be the responsible person for the purposes of compliance with the CRC.

It is imperative that businesses begin assessment of their organisations now in order to identify their relevant CRC group and sites. The relevant participant group will be that which was in place at the end of each qualification year. This means that for the introductory phase (see below), the group structure of an organisation as at 31 December 2008 will be the relevant organisation. The Draft Order contains provisions about how changes to a group structure should be accounted during the course of the Scheme.

Further lawnows exploring the consequences of the CRC for particular sectors (for example in relation to landlord/tenant relationships) will be published shortly.

Mechanics of the Scheme

Phase I – The introductory phase

The Scheme will run in a series of phases beginning with an introductory phase (phase I) running from April 2010 to March 2013 in order to accustom participants to the CRC. The introductory phase will involve a fixed price sale of emissions allowances expected to be £12 per tonne of CO2 per year. There will be no cap on allowances during this phase. At the end of the period, participants will calculate their actual emissions and submit an evidence pack (a footprint report) detailing energy use data to the Scheme Administrator. Participants will be able to buy and sell allowances through a secondary market (the cost of such allowances is uncertain) in order to cover any excess or shortfall.

The first sale of allowances will occur in April 2011, which will be a double purchase year. The purchase of allowances during this year will cover emissions from 2010-2011 and estimated emissions for 2011-2012. Allowances may be banked i.e. retained for use against future years' emissions. There are no restrictions on the organisations able to set up trading accounts and able to buy and sell allowances.  

Phase II – Cap and trade phases

From April 2011, the cap and trade phase of the scheme will begin.  Thereafter the Scheme will run in seven-yearly phases. At the start of each phase, there will be a one-year qualification phase and then a one-year 'footprint year'. Five compliance years then follow. During the cap and trade phase, the Government will set an annual allowance cap, and allowances will be available for purchase in a sealed bid uniform price online auction at the start of each compliance year. The annual allowance cap will decrease each year from 2013.

The cost of carbon allowances during this phase may differ from the fixed price during the introductory phase, depending on the carbon budget set for the sector. It will be for organisations to decide whether it is more cost effective to reduce their energy consumption or to buy a higher proportion of allowances and when they should purchase allowances.

During a qualification year organisations must monitor their electricity consumption in order to determine if they fully qualify for the Scheme. For the introductory phase, the qualification year was the 2008 calendar year. During the cap and trade phases, the qualification year will be the first year of each seven-year phase (i.e. for the first cap and trade phase, the qualification year will be April to March 2010-2011). Organisations not fully affected now should ensure that electricity usage is regularly monitored prior to each qualification date.

During a footprint year participants must calculate their total emissions and determine how many allowances they will require under the CRC. A footprint report must be submitted to the Administrator. For the introductory phase, the footprint year and the compliance year will be the same year (i.e. April 2010 to March 2011). For the cap and trade phase, the first compliance year will be April 2011 to March 2012. Those that qualify for the Scheme must register as a participant by the end of each footprint year. Organisations must register between April 2010 and September 2010 for participation during the introductory phase.

During each of the five compliance years of each phase, a participant should buy allowances via the online auction based on their expected energy use for that year and monitor their actual emissions. By the July following a compliance year, each participant must report their actual emissions to the Administrator and surrender a corresponding number of allowances in order to cover these emissions. Participants may buy or sell allowances on the secondary market during the course of the compliance year in order to ensure sufficient allowances are surrendered at this time (the price of which may vary to the auction price). In the October following a compliance year, performance related "recycling" payments will be made to participants (as described below).

The cap and trade phase of the Scheme will encompass a 'safety-valve' mechanism whereby participants may buy allowances directly from an Administrator. This is to protect the price of an allowance on the secondary market from becoming too high.  

The CRC performance table

At the end of each CRC year, a performance 'league table' published annually in October will rank participants. For the first year of the Scheme, a participant's place in the league will be calculated based solely on any early action taken to reduce emissions. For the following two years, four metrics will be used: 1) absolute emissions 2) relative emissions 3) early action, and 4) overall performance. Once the seven-yearly cap and trade phases begin, league table positioning will be determined by absolute and relative emissions and overall performance only (i.e. the early action metric will fall away).

Performance is to be assessed against a five year rolling average. For the initial phases of the scheme (i.e. before five years worth of data is available) performance will be assessed against the years for which data is available.

The performance table is designed to act as a driver for the reduction of carbon emissions as there is expected to be significant publicity surrounding the rankings. Further, organisations will be able to pitch their emissions data against their competitors in CSR type publications. The performance table will also form the basis of revenue recycling. Potential participants may therefore wish to consider taking early action programmes now in order to ensure they begin the Scheme in a positive position and obtain credit for 'early action ' whilst reducing electricity costs in any event. Others may consider that focused reduction in carbon emissions should commence once the baseline has started in order to obtain better 'bonuses' in future years albeit the effect of any savings will be delayed.    

Revenue recycling

The Scheme is designed to be revenue neutral. The revenues generated through the sale of allowances via the auction process (not the secondary market) will be 'recycled' back to participants. Recycling will be based on the participant's position in the annual performance 'league' table with bonus or penalty payments for those at the top and bottom. The scale of the bonuses and penalties will increase over time as the Scheme progresses. The recycled revenue will be returned to the responsible person within a combined participant for the whole group  (for example the parent organisation or the landlord).

What will participants have to do?

Initial requirements

Participants must initially:

· Register as a participant (including paying the registration charge, which is currently set at £950).

· Provide a footprint report to the Administrator.

Annual obligations

Each compliance year, a registered participant must:

· Provide an annual report to the Administrator. This annual report should include the actual energy consumption during the course of a scheme year.

· Sign a statement of records confirming that all requisite records have been kept (see further below).

· Comply with the performance commitment (i.e. surrender enough allowances to cover emissions).

· Buy any excess allowances required.

· Pay the annual subsistence charge (which is currently set at £1,300 p.a.).

· Co-operate with the Administrator and respond to any information requests.

How are carbon emissions calculated?

Whilst participation in the Scheme will initially be determined on electricity usage, once an organisation has qualified, all fixed point direct and indirect energy emissions must be included. This includes any mains electricity or gas as well as any on-site generation from fossil fuels (subject to the exceptions listed below). Emissions from transport or non-UK sites are not included.

For each energy source, the Government has provided a 'multiplier' in the Draft Order in order to calculate the total number of tonnes of CO2 emitted from that source. This data must be added together to calculate the total CO2 emissions for each participant. Emissions are self-certified. An independent audit of a proportion of participants (around 20%) will be undertaken on a rolling basis.


Emissions already covered by the EU Emissions Trading Scheme or a Climate Change Agreement will not be included within the CRC. In addition, organisations (or subsidiary organisations) with more than 25% of their energy use emissions covered by a CCA will be completely exempt from the Scheme. However, only the specific organisation will be exempt, not any related organisations (for example any parent company may still have to participate).

On-site generation

Any energy generated on-site from a renewable source will be zero rated for the purposes of the CRC and will not have to be reported unless Renewable Obligation Certificates ("ROCs") are already being claimed for the energy generated. If ROCs are claimed, the energy will be reportable and counted at the grid average emission factor.  

'Green energy'

The draft Order does not differentiate between the variable amounts of carbon emissions generated by different energy sources. For example an organisation purchasing 'green electricity' from a supplier will be allocated the same emissions as an organisation purchasing non-green electricity. There is no adjustment within the multipliers for energy from renewable sources such as off site wind or tidal schemes. The Government considers that the CRC is designed to promote energy efficiency and is focused on energy usage rather than renewable energy.  

Directors' duties under the CRC

Directors and other senior staff should be aware that a director or other person of similar status must sign a statement on an annual basis confirming that adequate records have been kept in accordance with the requirements of the Draft Order. This requirement is to ensure there is a high-level of awareness about the Scheme within a participating organisation.

Compliance and enforcement

The draft Order will be primarily enforced by way of civil sanctions. Importantly, the CRC does not utilise the newly created 'tool-kit' of civil sanctions available under the recent Regulatory Sanctions and Enforcement Act 2008 ("RESA"), but rather introduces its own version of civil sanctions as authorised by the Act. The sanctions in the CRC reflect the RESA sanctions to a degree (for example the fixed penalty levels are mostly set at £5000 per non-compliance), but many of the administrative and procedural safeguards of RESA have not been transposed into the Scheme (for example, the CRC does not detail the form of the fixed penalty notice). By contrast, the Marine and Coastal Access Bill, which is currently going through Parliament, incorporates more closely RESA model sanctions.

The level of civil sanction for most non-compliances under the Draft Order is set at £5000 (although the Administrator may reduce the level charged in certain circumstances). This is per non-compliance and consequently fines may accumulate quickly. For example, failure to register, failure to disclose information and failure to file a footprint report would result in a total maximum fine of £15,000. There are also penalties for incorrect reporting in respect of the footprint or annual reports. The Government has proposed a fine of £40 for each tonne of  CO2 that is incorrectly reported (beyond a set acceptable margin). All fines for non-compliances will operate on a strict liability basis, meaning that the penalty will accrue as soon as the non-compliance has taken place and regardless of the reason for non-compliance. Criminal sanctions are to be reserved for the more serious offences of fraud and where a participant has failed to comply with an enforcement notice issued by the Administrator. There is a right of appeal against all penalties. A participant may also appeal against their position in the performance league table where they believe the Administrator has made a mistake as to their positioning.

What are the implications for businesses?

Cost and cash flow

The CRC may give rise to cash flow consequences for some organisations. Recycling payments may be received many months after the initial monetary outlay for carbon allowances. For example, it is expected that initial expenditure required for the introductory phase of the Scheme will be in April 2011, whilst the first recycling payment may not be received until October 2011. There are also potentially high levels of civil sanctions for non-compliances (as described above). Nevertheless, others may view the cap and trade element as an opportunity to generate additional funds by trading excess allowances.  

Publicity and reputation

Decc has acknowledged that for some organisations, the scale of bonus/penalties within the recycling payments may provide insufficient incentive to change their energy use. However, they expect that ranking in the league table, and the subsequent associated positive or negative publicity will be a substantial driver.  

What should organisations be doing now?

Calculate your organisation's electricity consumption and prepare for scheme registration

Identify the appropriate organisational structure and identify all half-hourly meter within that structure, and which organisations may be exempt (if any).  

If you have not already done so, request an electricity use statement for all your half-hourly meters for 2008.

Register for the Scheme where appropriate. The Environment Agency has already sent out registration packs to organisations that have half-hourly meters. Organisations will have from April 2010 to September 2010 to register with the Scheme for the introductory phase. Importantly, all organisations that are contacted will need to respond to confirm whether or not they fall within the trading portion of the Scheme.

Take early action to cut energy consumption

The Government is stressing that taking early action to cut energy consumption will deliver cost savings to organisations which should not wait to make changes until the CRC is in force. The Carbon Trust has launched a new accreditation scheme for organisations, which can be used to show 'early action' under the CRC. Information about achieving accreditation under the standard and its role in the CRC can be found by clicking here.

Appoint someone to be responsible for the CRC

Participants should ensure they have sufficient expertise within their organisations to maintain compliance with the Scheme. This includes a nominated individual to act as the data manager both in terms of gathering and retaining information so that clear monitoring and verification of returns is possible at a later date. The Government's user guide may be foundby clicking here.