Manchester United and some 20 top energy performers are shined whereas interesting high-street brands such as Virgin Atlantic and Sheraton Hotels are shamed on the first ever CRC Energy Efficiency Performance League Table, published by the Environment Agency last Tuesday (8 Nov). The league table, however, is being criticised by major retailers as not being reflective of the true and whole picture of organisations’ efforts to reduce their environmental impact primarily because they are not compared like with like. Ricocheting in the minds of many entrepreneurs are the carbon reduction compliance procedures which have also been blamed to be overly complex and bureaucratic.
In June, the Energy & Climate Change Secretary, Chris Huhne, listened to this view and announced details of simplification to the CRC Energy Efficiency Scheme to make it more “business-friendly”. The policy document principally reviews the private sector organisational rules, CRC supply rules, qualification criteria, overlapping between similar carbon reduction schemes and timing and frequency of allowances sales from 2012 onwards. DECC will publish a green paper to consult the public on all areas where simplifications could be discussed early next year. When our carbon emissions still rose by 3% during a recession-sodden year – 2010, would this ‘pure’ simplification exercise for the CRC that is to accomplish the sacred mission of facilitating businesses to meet the UK’s stringent carbon budgets be the right thing to do? Would this become a commitment to businesses rather than to our environment? Can we turn it to be a commitment for both?
CRC Energy Efficiency Scheme
Launched last year, CRC is an important part of the policy jigsaw in shifting the UK to a low-carbon economy. It is a mandatory carbon emissions reporting and pricing scheme aimed at tackling barriers to the update of energy efficiency and cutting emissions in large, non-energy-intensive organisations in both private and public sectors, which are responsible for around 10% of the UK’s emissions. The scheme features an annual performance league table which ranks participants, including banks, hotels, hospitals and schools, on energy efficiency with a view to cutting Britain’s greenhouse gas emissions by 4 million tonnes and corporate energy bills by £1 billion a year by 2020. The first phase began in last September and enforced some 5,000 businesses (spending over £500,000 on energy bills a year) to reduce emissions. In the second phase (scheduled for 2013 instead of 2011 as originally planned) when carbon emissions will be capped, they will be required to buy carbon permits to cover emissions produced from their usage of heat and electricity.
The cheapest energy is ‘energy efficiency’ - the energy we don’t use. By design, CRC attaches a price to each tonne of carbon emitted from companies, which will escalate the emission issue to the boardrooms. Financial directors will have to justify the cost of energy inefficiencies. The scheme will instil behavioural change when businesses are required to monitor and report energy use. The league table can bring reputational motivation to companies as their environmental credentials are ranked against their competitors, according to the climate change minister. Another significant contribution of CRC is believably its capacity to create a market in energy-efficiency goods and services, carbon footprint assessment and carbon asset management, which is driven by surging demand from public and private sector organisations. DECC alleged that Phase 2 will present a natural point to implement a simplified scheme making compliance less burdensome for businesses.
Does a simplified version work out the same?
The writer does not oppose the scheme being more business-centric, provided that the government can bet on a simplified version stay really true to its intent of decarbonising businesses. To meet the carbon budgets that the UK is legally bound to achieve, scientists have advised that an annual decrement of 3% in emissions is necessary. Achievement of carbon reduction targets, by and large, can be a dichotomous project: the first strand being ‘extensive management’ (which targets energy-intensive industries without major difficulties); and the second one being ‘micro-management’ (which permeates across buildings, households and businesses). The CRC falls into the latter one that has to be supported by delicate policies, economic analyses and financial tools altogether. The UK indeed benefits from clear policy objectives and vibrant economic analyses, while the CRC is the financial tool that is needed but has not yet been developed towards the right direction. Perhaps the current carbon-cutting framework is beset by the problem of lack of policy coordination and ambition across a department and even the whole government. Let us examine a few aspects which the government are proposing to simplify.
Qualification criteria
Firstly, it is the proposed alignment of the two qualification criteria. In the current test for qualification, the participant must have at least one half-hourly meter settled on the half-hourly market; and its electricity supply through half-hourly meters (whether settled or not) during the qualification year was at least 6,000 MWh. Not only does such distinction between settled and non-settled meters result in confusion among participants, but also a ‘perverse incentive’ for organisations not to install smart meters, which would count towards their consumption for CRC purposes. If the availability of half-hourly meters is essential out of technical considerations, why don’t the government require all large energy users to install smart meters before the trading year, if Phase 2 is delayed by a year anyway? To this end, the smart meter rollout that adopts a supplier-led approach (rather than a regional approach) for completion by 2019 may not be synergetic with CRC.
DECC is considering aligning both criteria so that only consumption through settled half-hourly meters would count. Nonetheless, the writer is concerned that the overall emissions coverage will shrink and hence the CRC as a scheme is diluted if the 6,000 MWh qualification threshold is not lowered. The fact that the government have no intention to consult formally on this until spring next year will mean prolonged uncertainty that discourages businesses from initiating measures like data collection soon. Given the reporting data already submitted by participants in July, the extended consultation is not justifiable unless there are some hidden agendas. Of course, for the sake of ‘simplicity’ and a swift carbon-cutting effect, a better alternative would be to count all electricity supplied, rather than electricity supplied through half-hourly meters.
Reporting requirements
Secondly, the proposed simplification of the scope of energy reporting by participants also causes concerns. The current regulations require participating organisations at the beginning of each phase to prepare a “footprint report”, showing at least 90% of energy used from 29 fuels. The government propose to reduce the number of fuels covered by CRC from twenty-nine to four of which participants have to report 100% of their consumption. As the UK’s carbon budgets are stringent while commerce is one of the few sectors predicted to discharge increasing quantities of greenhouse gases (attributable to rising energy demand), every tonne of carbon savings counts. Besides, this proposal may be sending the market a wrong signal that pure ‘fuel switching’ is permissible and CRC would be reduced to a ‘game of numbers’. The government in this regard may be again “cutting too fast, too deep”.
With regard to businesses who have been complaining about the complexity and the burden of energy reporting, it is indeed quite interesting that similar comments are rare when it comes to annual financial information disclosure required by the Companies House or Stock Exchange. Does it say it is entrepreneurs’ mentality or ‘commitment’ to climate change mitigation that matters? To pave a path to possible extension of CRC to medium-sized businesses (which I will detail in later paragraphs), Whitehall should go one step further by considering making carbon reporting by all businesses mandatory in the near future.
More flexible organisational rules
Thirdly, DECC identifies the option for any undertaking in the group to be “disaggregated” from the rest of the group. Alongside with this is the proposal for qualification to be based on energy consumption of individual organisations and a group structure following accounting rules rather than Companies Act rules. The simplified scheme also requires organisations to group together based on their highest UK parent instead of their highest overall parent which may be located overseas. This proposal should be welcome by joint ventures and private equity funds for addressing current problems of “cross-contamination” within participant groups. Such move would also encourage every branch of a corporation to share the responsibilities of environmental management. Yet, this proposal which aims to offer flexible ways to participate in CRC will necessitate a significant lowering of the 6,000 MWh qualification threshold should the Tories-led government not intend to let a number of certain companies fall out of the carbon trading net.
Landlord and tenant rules
Fourthly, the definition of an energy supply is imperative as it assigns CRC obligation and responsibility to the right party, particularly if this scheme is to be extended to medium-sized businesses which are often tenants of offices. Although in most cases of building leases of a property the energy supply is normally procured by the tenant directly, it is appropriate for the government to maintain the current landlord and tenant rules because the landlords of a property, legally bound to undertake the responsibility under the CRC, are given incentive or pressure to increase energy efficiency in every petition of the whole buildings. Even without addition regulations for non-domestic tenancies, it is likely that, against the possible ‘rebound effect’ among tenants, a new type of leasing contracts with a proviso that the rental is based on an agreed monthly amount of energy consumption and surcharge is applied on tenants with higher meter readings emerge in the property market.
Removal of financial incentives
Last but not least, the most unwelcome and controversial decision is the government pulling the rug out from under participant organisations by removing the revenue-recycling mechanism. The revenue generated through sales of carbon allowances will be used to support public finances. Such move was criticised in March this year by the Confederation of British Industry (CBI) as turning the CRC into a “pure revenue-raiser”[1] and making it “untenable” if this major incentive was not to be reinstated. The revenue-recycling mechanism, designed by the former Labour government, denotes that the money raised by the CRC would reward businesses which reduce their carbon emissions the most.
CBI strongly disapproves of the removal of this financial incentive as it will undermine the credibility of as well as businesses’ and investors’ trust towards the scheme. In their report entitled “Back to the answer: making the CRC work”, CBI estimated that the removal of this major incentive will raise the cost of carbon from £1.20 to £12 per tonne, which potentially increases businesses energy bills by 7%. So does it run counter to the initial bills-saving objective of the scheme?
Although the Energy & Climate Change Secretary defended that this decision focus the government on “getting the best value for money and sending a clearer price signal to participants”, it is not obvious how the removal of this incentive can deliver it other than simply help pay off all sorts of debts not caused by a number of businesses committed to carbon reductions. If it is politically uncomfortable for the government to reinstate the initial revenue-recycling mechanism under the CRC, DECC is suggested to look into the possibility of separately creating a ‘non-domestic green deal’ which rewards companies or undertakings in a group with outstanding performance in energy efficiency improvement (to be detailed in later paragraphs).
UK set to miss carbon targets
Given the current pace of emissions reduction, the UK will predictably miss its 2020 renewables and carbon targets, according to Cambridge Econometrics. The country will narrowly miss carbon budget up to 2017, but by wider margins in the third and fourth carbon budget periods, i.e. 2018-2022 and 2023-2027. Although emissions from the government’s own activities in Whitehall, Westminster and across the country have fallen by some 14% in a single year, the emissions from the nation as a whole actually did grow during 2010. This suggests that existing policies have not succeeded in decoupling economic growth from carbon emissions. As the economy began a modest recovery, questions should arise on whether the strength of existing policies is sufficient to keep the country on the trajectory required to stay within its carbon budgets. Should the CRC be meanwhile intensified rather than purely simplified? Consistent with the opinion of the industries, new tools in climate policies, including a non-domestic green deal and a full cap-and-trade scheme, are recommended. A fully operational nationwide cap-and-trade scheme would potentially be able to generate substantial amount of revenue for the Treasury. These proposals will, however, require Downing Street to exercise cross-government leadership.
Non-domestic Green Deal
Rather than pure simplification, the right direction for the CRC should be gradual intensification to include medium-sized businesses and even charities or NGOs in the third sector in later phases. When interviewed by a magazine earlier, the Climate Change Minister, Greg Barker, said DECC has no plan to expand the CRC to smaller businesses, but they should take advantage of the Green Deal which will be open to any business operating out of a non-domestic property when it starts next autumn.
Nevertheless, the design of the Green Deal is arguably weak. Gloom remains over the level of expected take-up and whether it will deliver the scale of change needed to meet the UK’s carbon targets. It is mainly because the current design fails to (i) provide confidence that whole-house and area-based approaches will be carried out and; (ii) provide landlords with sufficient fiscal incentives to encourage uptake in the shadow of uncertainty around the transaction costs to be incurred and potential savings to be accrued. For instance, a solid wall insulation that on average costs up to £13,000 will not meet the ‘golden rule’.[2] The design of a domestic Green Deal may also not be suitable for every business with particular regard to the landlord-tenant dilemma.[3] Thus, non-domestic Green Deal targeting selected sectors should be considered.
In October this year, Ernst & Young published a report entitled “Making energy efficiency your business”, which highlights that a fine-tuned, non-domestic Green Deal has the potential for incentivising energy efficiency in small and medium-sized enterprises (SMEs). It is estimated that a 10% take-up under the non-domestic version would equate to a £800 million market of energy efficiency measures and around 5% of the carbon savings required form sectors not already included in the EU Emissions Trading Scheme by 2020.
At present, businesses who wish to increase energy efficiency of their properties can approach the Carbon Trust for advice and interest-free loans. However, operating as a ‘commercial’ consultancy or financier, the Carbon Trust itself is already receiving £50 million grants from DECC, BIS, Scottish Government, Welsh Assembly and Invest Northern Ireland a year. Setting up a non-domestic Green Deal to be implemented by an external social enterprise (merging the two government-backed green bodies - Carbon Trust and the Energy Saving Trust) may represent a better value for money for the Treasury. It is suggested that this body be partly financed by a one-off recoverable grant from the Treasury and partly capitalised by the Green Investment Bank in the next fiscal year. A portion of the tax revenue collected from an expanded CRC (which will be outlined in later paragraphs) may be used to reward organisations with the most outstanding performance. The government, therefore, should consider this as an option to partly restore the initial revenue-recycling mechanism under the CRC.
“London Carbon Exchange” with official certification system
The writer staunchly agrees with the CBI which advocates that the CRC should be ultimately moved towards a full cap-and-trade scheme as a robust financial instrument. It could be a powerful lever to revitalise the whole British economy through stimulating a series of green growth across the environmental, financial, commercial, trading and various associated services whilst in the long term generating substantial amount of tax revenue for the Treasury. The government now may be adopting a wait-and-see attitude towards the expansion of CRC to SMEs in consideration of possible chorus of disapproval from the industries or the transaction costs outweighing the benefits brought to businesses and the government given their smaller sizes.
In fact, an expansion of CRC to smaller organisations is highly justifiable. According to a study commissioned by the BIS in 2009, 97% of the UK businesses in high-emission sectors are SMEs. Today, there are over 4.8 million SMEs in the country and nearly 40% of SME businesses are the landlords of their properties. SMEs could collectively save nearly £400 million per year in energy costs, and over 2.5 million tonnes of carbon emissions, by reducing their carbon footprints and certifying their efforts under the Carbon Trust Standard.[4] As a result, the potentials of carbon reductions, transaction-related tax revenue and green jobs creation are massive.
An open trading market for carbon allowances
To move the CRC to a full cap-and-trade scheme covering large and medium-sized businesses, the government should model on the European Climate Exchange (ECX) to develop a national, open carbon trading market progressing from a fixed-price transaction phase. Given that carbon emissions nationwide have to be capped and annual decrement of 3% is necessary, it is a feasible option to allow the price of carbon permits to fluctuate (with a price floor imposed) and the market to decide it when the number of permits available in the market is becoming scarce.
This bold creation will bring participant organisations substantial momentum to optimise their environmental management by reducing further their carbon emissions. Leveraging on the world’s finest financial regulations, the new market will definitely be appealing enough to the bankers in the City who will develop a series of carbon investment products and derivatives. To “cut red tape” as what this government pledged during the election last year, therefore, Downing Street should consider negotiate with the London Stock Exchange to set up a separate trading market – “London Carbon Exchange” – where millions of CRC participants will complete transactions of carbon allowances. If corresponding financial taxes such as capital gains tax are charged in every carbon transaction, the Treasury should expect to receive a new, stable and permanent revenue stream worth tens of billions pounds a year.
Meanwhile, the government should ensure a level-playing field for organisations of all sizes. It is suggested that different trading boards be set up for businesses of different sizes. There are two major advantages: (1) Separate trading boards can protect smaller businesses from any (groups of) large businesses dominating the market by driving up carbon pricing at certain times; (2) A potential problem that larger businesses with advantage of economies of scales can better absorb the increased costs and price their products or services more competitively than can smaller businesses paying the same price for their carbon permits would be solved as different rules or price floors could be introduced in different trading boards.
Carbon price floor
The Chancellor, George Osborne, deserves credit for announcing two weeks ago to set up a price floor for carbon permits at £16 per tonne by 2013, rising to £30 per tonne by 2020, traded on the open market amongst energy-intensive industries (not under CRC system). In the first CRC trading year, participant organisations are supposed to purchase carbon allowances from the Environment Agency at a fixed price of £12 per tonne of emissions. Why don’t the government ‘install’ similar carbon price floors for participant businesses to trade in another open market run under CRC rules, say £12 per tonne for larger businesses, £7 for medium-sized businesses and £5 for not-for-profit medium-sized enterprises in the third sector? Larger businesses which wish to purchase carbon permits from smaller businesses on different trading boards would pay the price of £12 per tonne. By so doing, smaller businesses or social enterprises may be able to profit from selling surplus allowances.
Standardisation and official ratings
Alongside the new trading market, the country may benefit from standardised environmental policies or environmental management systems (such as ISO 14001) for businesses in different sectors. Mirroring the current credit ratings system, the government could even set up an official carbon ratings system through which every company, no matter large or small, for-profit or not-for-profit, would be ranked per annum according to its impacts on the environment. In parallel with possibly making it mandatory for companies to display carbon embedded with each product following PAS 2050 standard, an official rating of businesses’ environmental performance to be disclosed on product labels and/or all marketing materials would raise public awareness of how green a company is so that consumers can make more responsible choices.
Cross-government leadership
The UK needs a multi-pillar approach to tackle climate change, which is not simply the responsibilities of DECC, DEFRA or the Environment Agency. To achieve the carbon budgets, the government need to scale up their ambition with new tools in climate policies. All the measures proposed above indeed require inter-departmental collaboration and, more importantly, cross-government leadership to be demonstrated by the cabinet as a whole. The public increasingly aware of environmental depletion do not want to see the inter-departmental battle involving the Treasury and BIS that preceded the decision on the fourth carbon budget happen again. In lieu of intervening in every possible conflict of departmental priorities, the Prime Minister should demonstrate strong leadership by committing Whitehall in its entirety to the low-carbon transition. Otherwise, his party’s promise to be the “greenest ever” government will be no more than a fleeting show.
[1] CBI estimated that the CRC will be able to generate for the Treasury £715 million in 2011-12, rising to £1,020 million in 2014-15.
[2] The ‘golden rule’: A loan capped at £10,000 is linked to the energy meter in the property rather than the individual or property owner and only measures which will result in financial savings on energy bills in excess of the amount to be repaid on the finance will qualify.
[3] Landlords may not see any direct benefit from the Green Deal unless the improvements are reflected in the value of the property or its rental fee, whilst potentially bearing the risk in case of vacated property. However, an in-depth analysis on the Green Deal is beyond the scope of analysis of this article.
[4] The estimation is based on the 194,575 UK SMEs with between 10-249 employees.
Email me at winstonkm.mark@googlemail.com
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