CRC: Committee on Climate Change advises government on significant changes to the scheme

Practical Law UK Legal Update 8-503-4430 (Approx. 7 pages)

CRC: Committee on Climate Change advises government on significant changes to the scheme

by PLC Environment

Background: the CRC

Terms that appear with capital letters in this update are defined in Practice note, CRC Energy Efficiency Scheme: PLC glossary and abbreviations.

The CRC Energy Efficiency Scheme (CRC) is a new emissions trading scheme for non-energy intensive private and public sector organisations in the UK.

Participants are required to surrender Allowances to cover every tonne of carbon dioxide emissions associated with their energy consumption in the buildings that they own and occupy.

In the Introductory Phase of the CRC (which runs from 1 April 2010 until 31 March 2013), Participants will be able to buy an unlimited number of Allowances in a Fixed Price Sale, run by the Environment Agency. It is currently proposed that from 1 April 2013 to 31 March 2017 (that is, when Allowances are traded in Phase 2) onwards, the number of Allowances will be capped and that Participants will have to bid for a limited pool of Allowances in an auction held in April at the start of each Compliance Year. The cap would then be progressively tightened in each subsequent Phase, thus driving up the cost of Allowances and making energy efficiency measures increasingly more cost-effective for Participants.

For more information about:

The current proposals regarding auctioning for Phase two and subsequent Phases, see Practice note, CRC Energy Efficiency Scheme: overview: Auctions.
The CRC in general, see the CRC Survival Kit.

Committee on Climate Change's advice on Phase 2 of the CRC

In January 2010, the government and the devolved administrations asked the Committee on Climate Change (CCC) to provide advice on the level of the cap on Allowances that should be auctioned to Participants in Phase 2 of the CRC (see Legal update, CRC: Committee on Climate Change to publish advice to government on CRC cap on allowances).

On 24 September 2010, the CCC published a report advising the government on how the scheme should be changed in Phase 2 of the scheme, including the level of a cap that could be set on the number of Allowances to be sold to Participants.

The report considers three options for Phase 2:

Option 1: Have an auction with a minimum price.
- The scheme is already complex. Introducing a cap and auctioning of Allowances would add to this complexity (for example, Participants would have to develop purchasing strategies and learn how to bid in the auctions) and would have only a limited benefit in strengthening the incentives for energy efficiency measures.
- The CCC did not rule out the introduction of a cap and auctioning altogether, but it thought that before these elements were introduced to the scheme, evidence would be needed that the benefits of this additional complexity would outweigh the costs.
- The CCC asked SKM Enviros to undertake an analysis to model the potential for emissions abatement by the sectors covered by the CRC. This supporting research was published alongside the CCC's report. The analysis suggests that, if a cap is to be set for Phase 2, this could be set at a level that implies an annual emissions reduction of 4% (which would result in an emissions reduction of around 30% by 2017 relative to 2008 emissions levels.) However, the CCC notes there is considerable uncertainty over the base year (2008) emissions coverage of the scheme and that it has concerns about the limitation of two of the three modelling tools that have been used, so it is not clear if the emissions reduction indicated by the analysis is feasible. This introduces the risk that any cap set could be either too low or too high. If the cap is set too loosely, this could result in the price of Allowances crashing. Conversely, if the cap is set too tightly, the price of Allowances would spike in the absence of a safety valve. The CCC therefore recommends that the results of the analysis should be treated with "a high degree of caution".
Option 2: Replace the auction with the sale of an unlimited number of Allowances at a fixed price.
- The existing design that applies to the Introductory Phase (that is, selling an unlimited number of Allowances in a Fixed Price Sale) should continue into Phase 2, as this would provide equivalent financial and reputational incentives as a capped scheme, but with the benefit of avoiding the complexity of a cap and auction.
- Under this scenario, the government could set an emissions target for the CRC based on an assessment of the underlying potential and using funds generated from the sale of Allowances to:
- purchase Allowances in the carbon market to cover any shortfall in the CRC's delivery of emissions abatement; or
- address barriers to implementation of energy efficiency measures (perhaps by providing tax incentives or creating an energy efficiency loan fund).
Option 3: Reform the scheme more fundamentally.
The CCC believes that any fundamental redesign of the CRC (for example, reforming the way in which the revenue from the sale of Allowances is recycled back to Participants or dropping the need to buy Allowances) should be considered within the broader context of how to strengthen the price of carbon and would require better evidence on the way that specific financial incentives under the CRC actually work in practice.
The CCC concluded that it is not clear if the current revenue recycling arrangements reward energy efficient firms. In particular, firms that are already energy efficient may be penalised under the existing provisions.
The report discusses the possibility of dropping the revenue recycling element of the scheme. This would raise the cost of the scheme to Participants and, therefore, the profile of the scheme within firms. The report says that it is not clear how (on the evidence currently available) this would impact on incentives for energy efficiency. Although dropping the revenue recycling element of the scheme could be attractive from a fiscal perspective, the economic rationale would depend on the design of other carbon price instruments (such as the EU Emissions Trading Scheme and the UK's climate change levy).
The report discusses the possibility of dropping the financial incentives that the CRC provides (that is, strengthening the carbon price signal and raising the corporate profile of energy efficiency improvement) and developing it as a scheme to provide only reputational incentives through mandatory reporting and league tables. The report concludes that, in order to assess this option properly, further evidence is needed on the financial incentives provided by the CRC.
The CCC report also considers whether the CRC's threshold should be lowered. The policy landscape that currently applies to the commercial public and industrial sectors is complex. Organisations that are covered by the CRC may also be covered by the EU Emissions Trading Scheme, the climate change levy and climate change agreements. However, small to medium sized enterprises (SMEs) are subject to weak incentives to improve their energy efficiency. Analysis by the Carbon Trust suggests that the potential for smaller organisations to make emissions reductions is more widespread rather than for larger organisations.
Given all these points, the CCC recommends that there should be a review of the scope for streamlining policies to provide appropriate incentives for energy efficiency improvement without unnecessarily burdening organisations. If the design of the CRC were simplified for Phase 2, this would strengthen the case for lowering the threshold of the scheme. However, more work is needed to see if the emissions reductions that might result would justify the additional costs, or whether another type of scheme is more suited to smaller firms.

Other key points arising from the CCC's report include:

Treatment of the public sector under the CRC.
- Notwithstanding the cuts that are currently being made, the CCC considers that public sector budgets should be set to allow up-front investments in energy efficiency measures.
- There is a risk of a net transfer of funds from the public to the private sector if private sector firms are ranked higher in the League Table owing to their higher potential for energy efficiency improvement (27% as compared to the public sector's 14%) and managing energy intensity in the public and private sectors. To avoid this risk, the report recommends that there should be separate League Tables and revenue recycling for the public and private sectors.
Incentivising investment in renewable energy.
- Financial support for renewable energy should be provided primarily through targeted instruments such as the Renewables Obligation (RO), feed-in tariffs (FITs) and the Renewable Heat Incentive (RHI). The CCC report notes that the wider question as to whether these instruments provide sufficient incentives to investment in renewable energy will be covered in its report on this issue due to be published in 2011.
- The existing design of the CRC does not cover heat generation. The zero-rating of emissions associated with heat generated from renewable sources reduces the incentive on Participants to invest in measures to improve the energy efficiency of heating systems or the fabric of the building. The CCC therefore concludes that the CRC should require Allowances to be bought for all renewable generation including heat. This would be a change from the existing design of the scheme. However, it is proposed that renewable heat should be recognised in the context of the League Tables (presumably in the same way that is currently proposed for renewable electricity).
Addressing the barriers to the uptake of energy efficiency measures.
- The rationale for introducing the CRC was that existing policy measures did not give organisations in sectors where the costs of energy are a relatively small proportion of total costs, the necessary incentives to undertake energy efficiency measures. The CCC considers that the current design of the CRC will address some of the barriers to the uptake of energy efficiency (such as inertia, poor energy data and lack of senior management interest in carbon management) but that other barriers (such as finance constraints) are not addressed.
- The report concludes that complementary approaches (such as the provision of tailored information and guidance, and the availability of funding and loan instruments) will also be needed to ensure that the full abatement potential of these sectors is unlocked.

Responses to the CCC's report

Greg Barker, the Minister for energy and climate change, has said "My Department asked the Committee on Climate Change to provide advice on the CRC Scheme and today I welcome their response. I have made it clear before now that I want to simplify the bureaucracy of the CRC scheme that the Coalition Government inherited. Today’s report will help inform our thinking on setting the cap for CRC and will feed into our work on simplification of the scheme. In the meantime, I continue to urge businesses to register by the 30th September deadline." (see Committee on Climate Change: Carbon Reduction Commitment).

The reaction from business to the CCC's report has been very positive:

The Confederation of British Industry (CBI) applauded the CCC's "common-sense recommendations" and urged the government not to wait to simplify the scheme, which it described as "hamstrung by complexity" (see CBI news release).
The Engineering Employers' Federation (EEF) described the recommendation to scrap the cap and trade element of the scheme as music to its ears (see EEF blog). The EEF also said that "the Government must not underestimate the importance of combining a carbon tax with greenhouse gas reporting, in driving change within organisations. There should be a greater focus on the reporting element of the scheme, centred on Defra's carbon reporting guidelines, published last year. This should not be a wasted opportunity for Defra to promote a uniformed reporting methodology across sectors." And that, while it supported the recommendation to split the League Table into public and private sectors, it thought that this did not go far enough and it recommended that the government should enable companies to highlight the positive steps they are taking to reduce emissions rather than focus on absolute emissions, as that focus will lead to false results and will not act as a driver for organisations to become more carbon efficient throughout their operations.

Comment

Given the relatively narrow scope of the CCC's original mandate (to advise on the level at which the cap on Allowances should be set in Phase 2 of the CRC), it is interesting that the CCC has chosen to review and comment more widely on the design of the CRC as a whole. In any event, this dovetails with the coalition government's desire to review the design of a heavily criticised scheme it inherited from the previous Labour government.

Some of the options for reform that have been suggested by the CCC (such as an energy efficiency loan fund) were discussed, and rejected, when the Labour government originally consulted on the CRC.

However, it should be borne in mind that any potential reform of the CRC will need to be assessed in light of the various announcements the coalition government is expected to make in the Spending Review on 20 October, including proposals for changes to the climate change levy and the creation of a Green Investment Bank, as well as drastic cuts in public sector spending and the dissolution of a number of environmental bodies and quangos.

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