Who does the scheme apply to?

The Carbon Reduction Commitment (CRC) is a carbon trading scheme targeted at large non-energy intensive organisations. The Government estimates that between 4,000 and 5,000 organisations will be affected, and that by 2015, approximately 9% of the UK's total energy use will be captured by the scheme.

The scheme will be compulsory for organisations which exceeded the threshold of 6,000 MWh of half-hourly metered electricity usage between 1 January 2008 and 31 December 2008. In general terms, CRC may affect an operator of a modern data centre of about 5,000 square feet or more. Organisations that used less than 6,000 MWh will not have to participate in the first phase of the scheme but are required to make an "information disclosure" (providing details of their half-hourly metered electricity consumption).

The CRC scheme will be targeted at organisations rather than sites. As a general rule, the organisation that is the customer of the energy supplier will be the participant in the scheme. This means that where a landlord is responsible for the energy bill of a tenanted property, then (provided it meets the qualification criteria above) the landlord, and not the tenant, will be the scheme participant. Groups of companies will be viewed together as a single organisation for the purposes of the qualification threshold and for participation in the scheme.

The implication for the data centre sector is that those operators who recharge energy costs to their customers are likely to be participants of the CRC scheme. This is irrespective of the fact that the operators are not the end consumer of the energy.

How does the scheme work?

Participants will be required to "cancel" allowances equal to the quantity of their carbon emissions from all fixed point energy sources (not just electricity). However, for the time being emissions relating to transport will be excluded, as will emissions already covered by other schemes such as European Union Emissions Trading Scheme (EU ETS). Allowances will be sold to participants by the Treasury and will also be traded on a secondary market. If a participant can reduce its emissions it will need to buy fewer allowances, thus aiding its cashflow, and could even sell surplus allowances to other participants.

Every year the administrators of the scheme will produce a "performance league table", ranking participants according to their performance. This league table will be publicly available so there will be a reputational incentive for participants to perform well. Revenue raised from the sale of allowances will be recycled back to participants according to how they performed in the league table. This will include bonuses for good performance in the league table. Hand in hand with this it is envisaged that there may be financial "penalties" - reductions in the amount received under the recycling payment - for poor performance.

The scheme therefore creates both financial and reputational incentives for participants to reduce carbon emissions.

Issues for data centre operators

There are a number of key concerns for data centre operators. First is that, due to the energy consumption of their customers, operators will occupy the bottom of the league table - increasing the net cost of their participation in the scheme. Secondly, there is the question of whether the cost of purchasing allowances can be passed on to customers. If the answer to this is yes, careful thought is then needed as to whether, and if so how, the recycling payment is similarly passed on. These issues are considered in more detail below and in The Carbon Reduction Commitment: A guide for landlords and tenants. First, we will consider the key dates under the scheme.

What obligations arise under the scheme?

The first obligation will be for organisations with half-hourly meters to either register for the scheme or make an information disclosure, depending on whether their electricity consumption passes the 6,000MWh threshold. This must be done by 30 September 2010. Registration packs will be sent to half-hourly metered customers in September 2009.

Once registered, participants will be obliged to submit an annual report detailing their energy consumption by the last working day of July following the end of each compliance year (the first such report must therefore be submitted by the end of July 2011). Energy suppliers must assist participants by providing the information necessary for participants to be able to submit their report.

Participants will also need to cancel sufficient allowances to match their energy consumption by the last working day of July following the end of each compliance year. Allowances will initially be sold by the Treasury at a fixed price of £12/tCO2. From 2013 the CRC will move to an auction process for the sale of allowances and there will be a cap imposed by the Government on the total amount of allowances to be sold. Participants and third parties will also be able to buy and sell allowances on the secondary market. Discussions with a number of data centre operators suggest that the cost of the purchase of those allowances would not, typically, be capable of being recharged to customers under the terms of existing customer contracts.

What potential difficulties could arise from the scheme?

The aim of the CRC scheme - to reduce carbon dioxide emissions - should be welcomed. However, there have been complaints that the operation of the scheme is ill-conceived, particularly from the perspective of the UK data centre sector. For example:

  • Investment in renewable energy

There are concerns that the scheme could undermine the business case for investing in renewable energy. Under the current proposals the CRC does not make any distinction between renewable energy and energy sourced from conventional producers - all electricity will be assumed to have the average carbon intensity for the national grid. On-site generation will only be counted as zero carbon if the company opts to forgo the subsidy available under the Renewables Obligation.

The Department of Energy and Climate Change (DECC)'s rationale for this is to prevent "double counting". However, companies will now have to choose between claiming subsidies under the Renewables Obligation or counting electricity generated onsite as zero carbon. This is likely to radically affect a business case for investing in onsite renewable energy generation, and could discourage many companies from investing in such projects.

  • Performance league table

Concerns have been raised that the proposed performance league table will put organisations which have already taken significant steps to reduce their emissions at a disadvantage compared with organisations which only bring in measures in order to comply with the CRC. Organisations which have previously taken measures to reduce emissions may not see such a dramatic drop in their emissions during the relevant period and so could seem not to be performing particularly well.

The current proposals do make some provision for the league table to give credit to organisations that have taken certain defined forms of early/voluntary action, but these are narrowly drawn and it is unclear how this credit will operate in practice.

  • "Carbon dumping"

In the context of the data centre sector there is a concern that, far from encouraging energy efficiency, the CRC scheme will give rise to what is already being called "carbon dumping".

The purpose of the CRC scheme is to reduce absolute emission levels. The most effective way to achieve this goal is to encourage energy users responsible for emissions to reduce their energy consumption on the one hand, and adopt efficiency measures on the other. However, the current proposals allocate the entire carbon liability to the utility bill payer. In the case of many data centres, this is the data centre operator. The operator is not using or creating the demand for the products and services responsible for the carbon emissions. As a result, the onus to reduce emissions is placed at the wrong level.

The proposals could therefore encourage organisations to consider outsourcing their IT infrastructure and services, as a means of reducing their carbon footprint. In this situation the carbon emissions are simply transferred, instead of adopting genuine carbon-saving initiatives, such as virtualisation. Outsourcing would be a quick fix to the reputational damage a poor standing in the league table could cause.

While obvious "carbon dumping" could potentially lead to reputational damage, data centre outsourcing is a common practice. There would be no way of determining whether outsourcing that takes place post-CRC implementation is driven by genuine business reasons, or a desire to shift the carbon liability.

As energy costs in the UK are currently less competitive than in continental Europe, the additional carbon costs could also encourage businesses to move offshore. Data centres are by nature geographically flexible. This in turn will have wider implications for jobs in the UK, and data and application security.

Data centre operators may have the ability to reduce the carbon footprint in newer, more modern data centres. They can design their power infrastructure so that the customer becomes the utility bill payer, with the result that the carbon liability shifts back to the customer. The customer would then be incentivised to alter its behaviour and operate in a more energy-efficient way in the data centre. However, for pre-existing legacy data centres, the opportunities for energy efficiency are less widespread and the possibility of transferring the carbon liability back to the customer is also reduced.

  • Purchasing carbon allowances and recycling credits

For most operators of existing data centres where they are the utility bill payer, the CRC scheme will give rise to a financial liability which it will be difficult to quantify at this stage. The primary cost under the scheme is the purchase of carbon allowances. Depending on the operator's position in the league table, some of this cost may be "recycled" back to the operator in the future. However, any shortfall between the cost of purchasing carbon allowances and the credits recycled is unlikely to be recoverable under the terms of existing customer contracts. The same applies to the other costs of participating in the scheme, such as registration fees, and administration, monitoring and reporting costs.

This is ironic given that the number of the allowances purchased, and any credits received, are almost entirely a product of the energy consumption of the data centre operator's customers, rather than its own energy usage.

The data centre operator is also presented with a difficult dilemma. How many carbon allowances should it purchase? How should it go about second guessing the anticipated energy usage of its customers (and its future customers) in any year of the scheme?

The prudent course of action would be to purchase sufficient allowances to cover the committed maximum power draw of all of its customers. However, given that most customers' allocated maximum power draw is many times higher than their actual power consumption, such prudence would come at great expense.

Organisations are making costly and environmentally detrimental decisions to ensure that their data centres fulfil their primary objectives of round the clock operation and resilience. The result is that data centre occupiers consume less than 30% of their allotted capacity - and so perhaps anticipated actual energy usage is a more appropriate guide? This is likely to be a risky strategy given many data centre users' current drive to reduce costs by virtualisation and other techniques for the more efficient use of surplus data centre capacity.

  • CRC's impact on growth

The current proposals suggest that, after the initial phase of the scheme, rankings in the table will be determined by two metrics: absolute growth in emissions and relative growth in emissions. After this initial phase, the former metric is expected to be weighted at 75%, and the latter at only 25% (though it is unclear how DECC reached these figures). As a result, any business growth, even if accompanied by increased overall energy efficiency, could result in an organisation dropping down the league table - with corresponding financial and reputational effects. This is an unwelcome barrier to business growth, particularly given the current economic climate.

For example, if work moves from company A to more energy efficient company B, the league table will show company A as having improved its efficiency. In fact the liability would only have been transferred, leaving the same carbon inefficient practices in company A. Company B will be penalised, despite enabling an overall decrease in emissions through reducing the footprint of the transferred activity. The effect of Company B's decline in the league table may cause it to lose business it might have won elsewhere, alongside the added financial burden of having to buy an increasing amount of allowances to cover the transferred activity - at a higher cost once the cap is in place.

The danger is that the currently proposed arrangements would leave the data centre sector at the bottom of the league table. As the net cost of participation in the scheme increases for data centre operators, these costs will have to be passed (directly or indirectly) onto customers. Escalating IT services costs for UK corporates and the public sector could prove a deterrent to investment in IT, damaging UK competitiveness on the one hand and the energy savings from IT use on the other. Ironically the CRC scheme could lead to a decrease in the uptake of data centre space and an increase (certainly relative and possibly absolute) in carbon emissions as a result.

Conclusions

The CRC is designed to create a reputational and financial incentive for organisations to adopt energy efficient measures. However, the incentive mechanism is overly simplistic. It is neither targeted nor powerful enough to ensure the desired end result is reached.

The draft Order and accompanying user guide will undoubtedly be of assistance to organisations looking to prepare themselves for the CRC scheme, though it is possible that the recent consultation phase could give rise to further changes. DECC's "Regulatory Impact Assessment" report that accompanied the draft order and the consultation paper failed to recognise the impact of CRC on the data centre sector (though perhaps this is no surprise, since it also overlooked the largest of the users of IT - the financial services sector).

Like any new law, the real test of the scheme will be how it performs in practice. One thing is clear however - even though the scheme has been designed to be "administratively light touch", its introduction will place additional pressures on organisations that will have to find the resources to meet their obligations.

For the data centre sector, CRC presents two paradoxes with which it needs to come to terms. First, the more resilient the data centre; the better able it is to fulfil its purpose and ensure business continuity - the higher its energy consumption and therefore the greater its liability for CRC costs. It seems, therefore, that the data centre sector is being penalised for providing the level of security that UK business requires to thrive.

Secondly, the enabling effect of data centres is significant. They exist to house IT equipment, the purpose of which is to deliver IT services to support the UK digital economy. The infrastructure is simply a means to an end, and not the end in itself. This should be kept in mind when assessing their environmental impact. Indeed, most businesses look to IT systems to reduce their environmental impact in other areas.

Inevitably this leads to a contradiction - the data centre sector is heavily penalised, despite being the prime enabler of more environmentally-friendly IT efficiencies.