Summary

From April 2010, large non-energy intensive commercial and public sector organisations operating in the UK may become subject to the Carbon Reduction Commitment Energy Efficiency Scheme (CRC) - a new mandatory cap and trade scheme for carbon dioxide (CO²) emissions aimed at improving energy efficiency. Under the CRC, renewable energy is not deemed to be “carbon neutral”. Effectively this means that on-site renewable energy generators (OREGs) will have the same obligations under the CRC as consumers of fossil fuels.

The CRC and Renewable Energy

The CRC, commencing in April 2010, is a mandatory emissions trading scheme for the UK, designed to improve energy efficiency and to encourage investment in new technologies aimed at reducing CO² emissions. The CRC forms an essential part of the Government’s plan to achieve 80 per cent greenhouse gas emissions reductions by 2050.

A second fundamental part of the Government’s plan to meet its 2050 target relates to renewable energy generation. In particular, in order to increase the amount of on-site renewable energy generation in the UK, the Government has introduced two financial incentives: (1) the Renewables Obligation (RO) (which creates a market for renewable energy through requiring licensed energy suppliers to source a certain percentage of electricity from renewable energy sources evidenced by Renewable Obligation Certificates (ROCs)); and (2) as of April 2010, Feed in Tariffs (FITs) (a duty on electricity companies to pay a guaranteed, long-term, premium price for electricity generated by small scale renewable sources and exported to the national grid).

In order to prevent OREGs from benefiting under both the CRC (as a producer of zero emissions) and other financial incentives (ROCs and FITs), the Government has provided that the CRC will treat renewable energy consumption as emitting an equivalent amount of CO² to Grid Average Emissions (the average CO² emissions per unit of electricity supplied by the national grid).

The treatment of renewable energy under the CRC has created significant confusion for OREGs and companies considering reducing their CO² emissions by implementing micro-generation technologies. This briefing note seeks to clarify how the CRC will apply to OREGs, to highlight the challenges and opportunities which CRC participation may provide, and to suggest practical steps which OREGs may take to prepare for the CRC’s onset.

The CRC and its application to OREGs

When will the CRC start?

The CRC will commence on 1 April 2010 and will run for set periods referred to as “phases”. Each phase will last for seven years, with the exception of the first phase (the “introductory phase”) which will run for three years only (beginning in April 2010). Each year in a phase is known as a “compliance year” and will run from 1 April to 31 March.

CRC Participation

Organisations (including OREGs) will be required to participate in the CRC where, during the “qualification period” (i.e. the 2008 calendar year for the introductory phase, and the financial year (April-March) prior to the first compliance year for subsequent phases), their UK operations:

  • consumed at least 6,000 mega-watt hours (MWh) of electricity (equal to approximately £50,000 of electricity bills / annum); and
  • had at least one half hourly meter (HHM) settled on the half hourly market (a meter which records total electricity consumption every half hour and automatically transfers this information to the energy supplier).

Organisations participating in the CRC may include UK and non-UK incorporated companies, partnerships and other unincorporated associations which operate (and therefore use electricity) in the UK.

The following should be considered when assessing whether the qualification criteria have been met:

Group company participation: For the purposes of qualification, group companies will be treated as a single entity under the CRC and the group’s total UK electricity consumption will be aggregated. Groups may disaggregate Significant Group Undertakings (SGUs) (i.e. group members which would be capable of meeting the CRC qualification criteria in their own right) where the remainder of the group still qualifies for CRC participation. Following disaggregation, the group and the SGU will participate separately in the CRC.

Landlord and tenant participation: In relation to leasehold property, the party having responsibility for the provision of energy to the building (i.e. as counterparty to the electricity bill) will have responsibility for CRC compliance (should the qualification criteria be met).

Energy services arrangements: Where renewable energy plants are operated by third parties under an energy services arrangement exclusively on behalf of an organisation, that organisation will be responsible for CRC compliance (should the qualification criteria be met). However, if the plant is operated for the benefit of several organisations, the energy plant operator will need to assess whether it qualifies for CRC participation on its own behalf.

Non-qualifying organisations

Should an organisation have a HHM but not meet the electricity consumption threshold set out in the qualification criteria, it may still need to submit an information disclosure to the CRC Administrator (i.e. the Environment Agency (EA) in England and Wales, the Scottish Environment Protection Agency (SEPA), and the Northern Ireland Environment Agency (NIEA)). Organisations required to make an information disclosure must provide the CRC Administrator with a list of its half HHMs and calculate how much electricity it was supplied with through all HHMs during the qualification period (this must be disclosed if it is greater than 3,000 MWh). Organisations failing to make an information disclosure will be fined £500 per HHM not disclosed.

How will CRC work?

Registration: Organisations (including OREGs) which qualify for CRC participation will be required to register with the CRC Administrator for participation. The registration period runs from April to September during the first compliance year of each phase.

Calculating emissions: Participation in the CRC is governed by the calculation of a CRC participant’s CO² emissions from its energy use (i.e. consumption of electricity, gas and any other types of fuel such as coal, LPG and diesel) minus exempt emissions. Exemptions include emissions from transport, domestic consumption, consumption outside the UK and activities covered by the EU Emissions Trading Scheme (ETS) and/or Climate Change Agreements (subject to certain thresholds). A CRC participant’s CO² emissions will determine the number of allowances that it will be required to purchase (and surrender) to comply with the CRC scheme. (For information on calculating emissions for OREGs, see the Treatment of Renewable Energy under the CRC, below).

Purchasing allowances: For each compliance year, CRC participants will need to purchase sufficient allowances (on the primary or secondary market) to cover their annual CO² emissions. One allowance will be the equivalent of 1 tonne of CO². CRC participants holding more allowances than they need may bank allowances for future use. The only exception to this is that in the final year of the introductory phase, all remaining allowances will be cancelled. During the introductory phase of the CRC, allowances will be sold on the primary market at a fixed price of £12/tonne CO². However, from April 2013, the total pool of allowances will be capped and subject to auction. Mechanisms have been put in place under the CRC to ensure that the price of allowances sold on the secondary market will not exceed those sold on the EU ETS market.

Emissions management: CRC participants will be encouraged to develop systems to manage their CO² emissions and to use energy efficient technologies. CRC participants using more energy than they originally predicted will need to purchase additional allowances to fulfil their CRC obligations with obvious cost consequences.

Annual reporting: CRC participants will be required to submit an annual report to the CRC Administrator detailing their emissions (OREGs will need to provide additional information specific to their use of renewable energy). Annual reports must be submitted by the last working day of July following the relevant compliance year (e.g. July 2011 for the first compliance year of the introductory phase (2010/11)). In addition, a footprint report (setting out information on a CRC participant’s total CO² emissions from energy consumption in addition to details of any exempt emissions and use of fuels which are zero rated (including type and quantity)) must be submitted by the last working day of July following the end of the footprint year (the first compliance year in each phase).

Performance commitment: CRC participants will be required to surrender allowances corresponding to their total CO² emissions to a cancellation account by the last working day of July after the end of a compliance year (with the exception of the first compliance year in the introductory phase). The CRC Administrator will then cancel the allowances.

League table: Following annual reporting, the CRC Administrator will publish a league table showing how all CRC participants have performed under the CRC. Participants will be ranked in the league table according to how they have performed against three metrics - (1) early action (i.e. fitting automatic meter-reading equipment and/or meeting Carbon Trust (or equivalent) standards); (2) absolute growth in emissions (i.e. percentage change in emissions); and (3) relative growth in emissions (i.e. carbon intensity of any growth or decline in turnover). Whilst the league table will be weighted in favour of the early action metric in the first compliance year of the Introductory Phase (i.e. April 2010-March 2011), early action will not be considered from April 2013 onwards and the league table will be largely calculated with reference to the absolute growth metric.

The treatment of renewable energy under the CRC

OREGs will not need to report on, or purchase and surrender allowances to cover, emissions arising from their primary fuel input (if any) and from the generation, distribution, transmission and supply of renewable energy.

Where electricity generated is used by the OREG (known as “self-supply”) its consumption will be treated as emitting an equivalent amount of CO² to Grid Average Emissions. Equally, a CRC Participant which purchases and consumes renewable energy from an OREG will also be deemed to produce Grid Average Emissions.

Where ROCs or FITs are not issued in respect of the renewable energy generated, an OREG may claim electricity credits (irrespective of whether the energy is for self supply or supply to the national grid or a third party). Electricity generating credits can be subtracted from a CRC participant’s CO² emissions. Where a CRC participant’s electricity credits are greater than its total energy consumption, it will be able to report energy consumption as “zero”.

Specific opportunities and risks for OREGs

Opportunities

Electricity credits: Where OREGs receive electricity credits, their CO² emissions will be reduced meaning that fewer allowances need to be purchased (and surrendered).

Recycled payments: Based on ranking in the league table, revenues received from the sale of allowances will be recycled back to CRC participants. In essence, this means that high performance (and therefore league table position) will be rewarded by bonuses in the form of “recycled payments” (predicted to equate to up to 150 per cent of the original outlay for allowances by 2020) in addition to good publicity.

Cost savings: Compliance with the CRC has the potential to make CRC participants more energy efficient which could generate cost savings.

Publicity for renewable energy generation: Details of a CRC participant’s onsite renewable energy generation will be published alongside (but separate to) the league table which may result in good publicity (though no financial rewards).

Risks

Electricity credits: Although OREGs may choose to forgo ROCs/FITs (or to export their generated energy) in order to gain electricity credits, financial analysis of various organisations has revealed that the financial benefits of doing so may be less than they would have gained by receiving ROCs/FITs (and/or consuming their own energy).

League table ranking: CRC participants who fail to perform under the CRC will be “named and shamed” by the publicity of the league table, and will in effect bear extra costs (because they will not benefit from recycled payments).

Civil liability: In the event of non-compliance with the requirements of the CRC, the CRC Administrator may impose civil penalties and may publicise the non-compliance. For example, in the event of failure to register under the scheme deadlines or for failure to submit an annual report, a fixed penalty of £5,000 (and daily fines thereafter) may be levied. In the event of failure to carry out the performance commitment, a fine of £40/tonne of CO² may be levied in respect of each allowance that should have been obtained.

Criminal liability: CRC participants may incur criminal liability where, for example, they have failed to comply with an enforcement notice or attempted to deceive or mislead the CRC Administrator. Criminal penalties can include fines up to £50,000 (on conviction in the Magistrates’ Court), or an unlimited fine (on conviction in the Crown Court). Group companies participating in the CRC as a single entity will be jointly and severally liable.

Directors’ and officers’ liability: Individual directors and officers may be subject to personal liability where an offence is proved to have been committed with their consent, connivance or neglect. In extreme circumstances, they could be subject to imprisonment for a term not exceeding three months on conviction in the Magistrates’ Court, or for a term not exceeding two years on conviction in the Crown Court.

Cost: The CRC is likely to significantly increase the cost of using energy in the UK as participants will need to purchase allowances in proportion to their energy consumption. In addition, participants will be required to meet the administrative costs of scheme participation (e.g. CRC participants will need to pay a registration fee of £950 in addition to an annual subsistence fee of £1,290).

Steps to become CRC ready

OREGs which potentially qualify for CRC participation can prepare for the imminent implementation of the CRC by taking the following steps.

Assessing qualification: Obtain information on electricity consumption for 2008 (the proposed base year).

Prepare to calculate emissions: Assess sources of emissions (e.g. energy used for which ROCs/FITs have been claimed) and sources of zero CO² emissions (e.g. electricity consumed as part of generating the renewable energy).

Consider forgoing subsidies or exporting energy: OREGs should assess the financial benefits of receiving Government subsidies (ROCs and FITs) and/or consuming energy generated as opposed to receiving electricity credits and/or exporting energy to the national grid.

Establish organisational responsibility: Appoint a CRC Co-ordinator (preferably a director or senior manager) to be responsible and accountable for CRC participation and supported (as appropriate) by a team of CRC Officers to assist in data collection/purchasing of allowances.

Budget for compliance: Assess the likely costs of CRC participation including administrative costs and the costs of purchasing allowances to allow for forward planning/budgets. Although the cost of purchasing allowances has the potential to be recycled back at a later date, the time lapse between purchasing allowances and receiving any recycled payment (approximately 6 months) will inevitably affect cash flow.

Data capture and reporting: Participants may consider implementing new systems such as automated data collection networks (sub-meters) to make the capture of data more efficient, regular and reliable.

Maintain records: Familiarise the designated CRC team (including the CRC Co-ordinator and CRC Officers) with the record keeping requirements under the CRC and plan for on-going compliance (e.g. data collection and filing). Training programmes may need to be set up for this purpose.

Plan for energy efficiency: Plan to improve energy efficiency through, for example, retrofitting buildings with energy saving technologies and providing staff training and incentives to reduce energy use.

Early action metric: Consider meeting the Carbon Trust (or equivalent) standard by March 2011 in order to benefit from the Early Action metric.

Consider CRC compliance in transactions: A CRC participant entering into a transaction such as the sale or purchase of another company should have regard to the potential effect of the transaction on its energy use (and therefore use of allowances). Failure to carry out thorough due diligence may subject the CRC participant to risks such as reputational and financial loss (through poor league table positioning).

Seek legal advice in relation to contracts (including leases): Legal advice may be sought in relation to transferring responsibility for CRC compliance and/or costs and benefit (recycled payments) sharing under the CRC. This will be particularly relevant to leasehold property where landlords and tenants will require separate legal advice.

Lobby the Government: OREGs may continue to lobby the Government to recognise and incentivise the growth of renewables on their own behalf or through their industry bodies. The Government has indicated that it will review the CRC in 2011 with a view to consulting on amendments in 2012 and publishing any changes in 2013.