An economic theory that until 1997 was virtually unknown in the energy industry is now the primary mechanism for reducing carbon emissions across Europe.

Already applied to energy-intensive industries, the UK government will introduce it to many of the country's largest energy users from 2010.

At its most fundamental, this means that greenhouse gas emissions now become assets or liabilities with a financial value. Reducing exposure to these costs - and maximising the value of efficiency savings - therefore becomes more important in the financial management of the organisation.

So energy management is a business priority, as well as a political priority for government.

'Cap and trade'

Schemes like the EU Emissions Trading Scheme (EU ETS) work by imposing a ceiling on total allowable emissions. This total is then divided up between participants, either by free allocations based normally on previous performance or by auctioning of allowances.

At the end of the accounting period, those in the scheme must surrender allowances equivalent to their emissions. If their emissions are higher than budgeted, they have to buy extra allowances on the market. If lower, they can sell the surplus emissions.

Year by year the ceiling is reduced, encouraging participants to reduce their emissions as the available total is lower and prices for (scarcer) allowances higher. Whether they reduce (through efficiency investments) or pay the premium depends on which is cheaper. Therefore, the total is capped and progressively reduced, but at least overall cost to the scheme participants.

As the Carbon Reduction Commitment (CRC) will be the first time most organisations will have been involved in trading emissions allowances, there will be no cap set for the first three years. Allowances will be sold at a fixed rate of £12 per tonne of CO2 and participants will be free to buy as many as they wish.

The cap-and-trade system starts in 2013, at which point the government will set an overall target and the availability of allowances will be progressively reduced, leading - in theory at least - to rising carbon prices and greater incentives to invest in efficiency measures.

The EU ETS only applies to energy-intensive industries. But there are many large energy users that do not fall into the heavy industry category. The UK government - now legally committed to reducing greenhouse gas emission by 80 per cent by the middle of the century - has therefore introduced a new scheme to bring emissions trading to these groups too. From 2010, any organisation spending more than £500,000 a year on electricity is likely to be captured.

Who is included?

The CRC will cover organisations with half-hourly electricity metering and an annual electricity demand of 6,000 megawatt-hours (MWh). The metering does not just apply to the mandatory systems for those with a maximum demand of 100kW or more - but also to anyone who has installed them on a voluntary basis (e.g. remotely read Automatic Meter Reading systems that produce half-hourly data). It is also likely to cover organisations with many smaller sites e.g. public houses.

In the public sector, all state-funded schools will be included in the CRC, their emissions forming part of the relevant local authority's accounting responsibility (independent schools are not included unless they exceed the half-hourly consumption threshold).

There are a few exemptions from the CRC but these apply to organisations already involved in other trading schemes - notably the EU ETS or Climate Change Agreements. In effect, from 2010 virtually all large energy users will be involved in emissions trading in one way or another (it has not yet been formally decided whether hospitals and other NHS bodies will be included in the CRC; a consultation is promised).

The CRC targets the UK emissions of 'the highest parent organisation'. The electricity use of any subsidiaries that have half-hourly metering will be aggregated into the group's total. The parent will then be responsible for reporting total emissions from energy use. Subsidiaries themselves need to ensure that parent organisations are informed of any liability for inclusion.

Timelines

The qualifying period was the calendar year of 2008. So check your invoices now to see if your organisation is included in the scheme. The Environment Agency, which is administering the scheme, will be sending out letters in July this year to anyone on their records with half-hourly metering asking them to confirm eligibility. Participants need to formally register during the course of 2010 - between the beginning of April and the end of September, to be precise. Even those not captured are legally required to respond.

It should be noted that, although annual electricity demand is the qualifying criterion for the CRC, the scheme itself covers all energy use - gas, oil and solid fuels as well, but not transport fuels. So records need to be kept of all energy/fuel purchases as they will all be relevant to the scheme.

Although the qualifying year is the calendar year of 2008, the compliance periods will run according to financial years, so the first will be from April 2010 to March 2011. Emissions have to be monitored throughout the year, with a final report provided by the end of the period. This will be done via an online registry and allowances corresponding to the total will have to be surrendered at the same time.

Buying allowances

Allowances at £12 per tonne of CO2 will be sold annually to begin with. The first sale will be in April 2011 and, uniquely, will cover two years - retrospectively for 2010-11 and forward for 2011-12. Future sales/auctions will be for the forward purchases.

Minimising exposure

The CRC is designed to be 'revenue-neutral' - at least as far as the government is concerned. So the monies collected will be recycled to participants. However, straight recycling would not carry any incentives, so all those taking part will be listed on a league table showing improvements in energy efficiency over the accounting period. Funds will be allocated accordingly, with high achievers earning more than those making little or no improvement.

There are several factors that modify the amount to be repaid:

• Reductions in absolute emissions;
• A growth metric;
• Two early adopter measures:
• Membership of the Carbon Trust Standard scheme;
• Installation of aM&T systems.

The reduction in absolute emissions compares current and previous performance. It can be used to make comparisons across different sectors and locations.

The growth metric allows for changes in productivity. If a business increases output from a site, then its emissions are likely to rise even if it invests in energy efficiency: the growth metric ensures that the organisation is not penalised for this. The public sector criterion is based on revenue expenditure.

The early adopter elements reward early action, even before the scheme starts. The Carbon Trust Standard (formerly the Energy Efficiency Accreditation Scheme) is a third-party recognition of an organisation's efforts to improve efficiency and its commitment to continuing improvement. Further details are available from the Carbon Trust (www.carbontrust.co.uk).

Automatic Monitoring & Targeting (aM&T) systems are increasingly seen as an effective means of monitoring energy consumption - and controlling it. The Building Regulations give an allowance against carbon targets for installing these systems and the government is promoting smart metering systems as a way of improving energy efficiency in all types of building. aM&T is a powerful tool in managing energy use (and controlling emissions) effectively and should be considered as a cost-effective investment.

The recycling payments at the end of the first year will not be based on a league table of efficiency improvements - there will be no prior year upon which to base a comparison. So these three modifying factors will be the only determinants of allocation priorities, making it worthwhile to consider membership of the Carbon Trust Standard and installation of aM&T systems.

At the end of the first year, allowances can be bought based on actual performance over the previous year. But after that, allowances will have to be bought based on forecasts. There is a financial risk here - buy too many and you could be faced with selling surplus in an over-supplied market (this happened in the first phase of the EU ETS), leading to a financial loss. The opposite could also happen, with too few allowances purchased in advance and a requirement to buy on the spot at whatever price is offered.

The only way to minimise exposure is to keep close control over consumption, through effective energy management techniques - especially aM&T. Emissions trading is here to stay and the sooner an organisation understands the risks and the opportunities, the less likely it is to lose financially.


ESTA is organising a national conference on the benefits of automatic Monitoring & Targeting at the Ricoh Arena E.ON Lounge, Coventry, on Wednesday 25 February 2009. The conference is free to attend.

Visit the ESTA website to register - www.esta.org.uk