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CRC: Government scraps recycling of revenue from the sale of allowances
Practical Law UK Legal Update 4-503-7204 (Approx. 10 pages)
CRC: Government scraps recycling of revenue from the sale of allowances
by PLC Environment
| Published on 26 Oct 2010 • UK |
On 20 October 2010, the government announced in its Spending Review that the revenue from the sale of allowances in the CRC Energy Efficiency Scheme will no longer be recycled back to participants.
Speedread
On 20 October 2010, the coalition government announced in its Spending Review 2010 that the:
- First sale of allowances under the CRC Energy Efficiency Scheme (CRC) for 2011/12 would take place in 2012 rather than 2011.
- Revenue raised from the sale of CRC allowances would not be recycled to participants in the scheme but instead would be used to support the public finances.
The CRC, which came into operation in April 2010, applies to many large and medium sized organisations in the private and public sectors in the UK. The announcement about the recycling of payments has generated a great deal of controversy.
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 (CO2) 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 (EA). As the CRC was originally designed, the revenues raised annually from the sale of Allowances were to be recycled back to Participants. The Revenue Recycling payment received by each Participant was to be based on its proportion of the total CRC Emissions in 2010/11, adjusted by a bonus or penalty payment which is calculated from the Participant's position in the League Table published in October each year.
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. The Climate Change Committee (CCC) published a report, on 24 September 2010, advising the government on changes that could be made to the CRC in Phase 2 (see Legal update, CRC: Committee on Climate Change advises government on significant changes to the scheme).
The CRC Energy Efficiency Scheme Order 2010 (SI 2010/768) (the CRC Order) contains provisions on:
- How Allowances will be held in the Registry (article 55 and Schedule 7).
- How Allowances will be surrendered to the Administrator in each Annual Reporting Year (articles 52-54).
- The construction and publication of the League Table (also known as the Performance Table) (articles 75-80 and Schedule 8).
However, the CRC Order does not contain any details about how Participants will buy Allowances in the Fixed Price Sale or the auctions, or how the revenue from the Fixed Price Sales or auctions (as relevant) will be divided between Participants. The details relating to the:
- Fixed Price Sales are contained in the Draft CRC Energy Efficiency Scheme (Allocation of Allowances for Payment) Regulations 2010 (Draft Allocation of Allowances Regulations).
- Revenue Recycling payments are contained in Chapter 6 of DECC: Consultation on the Draft Order to Implement the Carbon Reduction Commitment - Government Response and Policy Decisions (7 October 2009).
Since taking office in May 2010, the coalition government has indicated on a number of occasions that it thought the CRC was unnecessarily complicated and that it would review the design of the scheme to simplify it. In August 2010, Greg Barker, the Minister for Energy and Climate Change, called for "suggestions as to how we can make the scheme simpler in the future". And in September 2010, he said "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".
For more information on:
- The current design of the CRC, including the League Table, Revenue Recycling payments and the auctioning of Allowances, see Practice note, CRC Energy Efficiency Scheme: overview.
- The CCC's recommendations for Phase 2, see Legal update, CRC: Committee on Climate Change advises government on significant changes to the scheme.
- The government's comments regarding its intention to review the CRC, see DECC Press Release: 50 days for businesses to register with carbon cutting scheme (11 August 2010) and Committee on Climate Change: Carbon Reduction Commitment.
- The CRC in general, see the CRC Survival Kit.
What changes were announced in the Spending Review?
On 20 October 2010, the Chancellor of the Exchequer, George Osborne, set out the government's four-year public spending plans in the Spending Review 2010 (SR 2010). Chapter 2 of SR 2010 included the following information about the CRC:
- The first sale of Allowances for 2011/12 emissions will now take place in 2012 rather than 2011.
- Revenue from the sale of Allowance sales (which the Treasury estimates will total £1 billion a year by 2014-15) will be used to support the public finances (including spending on the environment), rather than recycled back to Participants in the scheme.
- Further decisions on the sale of Allowances are a matter for the Budget process.
The EA, which is the main Administrator for the scheme, made the following statement on its website:
"Changes to the CRC Energy Efficiency Scheme have been announced as part of the Government's Spending Review. The Environment Agency can provide no further information on these changes at this time. We will be working with the Government to understand the implications of these changes and will provide you with further information as it becomes available."
The Department of Energy and Climate Change (DECC's) website says that the CRC User Guide will be updated to reflect the recent announcements on the CRC made in the SR 2010. Presumably, the EA's various guidance documents on the CRC (which can all be found in Practice note, CRC Energy Efficiency Scheme: links to primary sources) will also be updated in due course.
What areas of uncertainty remain following the announcements in the SR 2010?
The timing of the first sale of Allowances
The CRC has been designed so that Allowances for an Annual Reporting Year would be bought in April, at the start of the year in question. Article 52 of the CRC Order provides that Allowances will be valid for the year in respect of which they were issued and any subsequent year. However, Allowances in the Introductory Phase cannot be used in subsequent Phases. Using Allowances purchased in any given Annual Reporting Year to meet the obligation to surrender Allowances for a preceding Annual Reporting Year (known as "carry-back") is not allowed under the CRC except in the specific circumstances outlined in article 52(2).
The wording in the SR 2010 indicates that Allowances will need to be purchased for Annual Reporting Year 2011/12. Article 53 of the CRC Order requires Allowances to be surrendered for the second and third years of the Introductory Phase (that is, for 2011/12 and 2012/13). Unless an amendment is made to the CRC Order, Allowances will need to be purchased in 2012 whenever the first Fixed Price sale of Allowances is held, in respect of 2011/12. However, buying Allowances for 2011/12 in the Fixed Price Sale in 2012 will amount to a carry-back, which is prohibited under article 52. It seems, therefore, that the CRC Order will either have to be amended to make 2011/12 a reporting-only year or to permit carry-back in this situation.
The Draft Allocation of Allowances Regulations will need to be amended to provide precise details of the dates of the Fixed Price Sale and Safety Valve "windows" in 2012 and 2013.
It would appear that the intention behind the announcement is simply to give Participants a further year when they do not need to budget for, or buy, Allowances, rather than to require Allowances to be purchased for surrender following the end of each Annual Reporting Year as some commentators have suggested. The effect would therefore be to turn the 2012 Fixed Price Sale into a double sale, so that Participants would also need to buy Allowances for 2012/13 at the same time.
Organisations that have already made a budgetary provision for the purchase of Allowances for 2011/12 will need to revise their budgets and cash flow forecasts for 2011.
What about the other changes to the CRC recommended by the Committee on Climate Change?
There was no indication in the SR 2010 as to whether the government is planning to make any other changes to the CRC and, if so, when or what it intends to do with the various recommendations made by the CCC on 24 September 2010 (such as making Phase 2 and subsequent Phases uncapped and subject to Fixed Price Sales rather than auctions, lowering the threshold for participation in the scheme, separating the public sector into a different League Table, and expanding reporting to cover the CO2 emissions associated with the consumption of heat).
The impact on the League Tables of cancelling revenue recycling
It is not clear if cancelling Revenue Recycling payments will have any impact on whether and how the League Tables are constructed.
The reasons for constructing the League Tables were two-fold:
- To use reputational drivers (that is, the fear of being ranked below competitors in the same sector) as a means of encouraging energy efficient behaviour in Participants.
- As a means of calculating the bonus or penalty element that would be applied to a Participant's share of the revenue raised from the sales of Allowances.
Now that one of the reasons for the League Tables has been removed, do they need to be so complicated? Of course, any changes to how the metrics are calculated require a change to the CRC Order.
The impact on trading of cancelling revenue recycling
The CCC's report on Phase 2 considered dropping the sale of Allowances and making the CRC a reporting-only scheme, so that it focused on reputational drivers. This was in the context of a reform of other instruments, such as the climate change levy (CCL).
It would appear that the government sees the CRC as a significant source of revenue, which would mean a decision not to scrap the sale of Allowances. However, it is not clear if subsequent Phases will be uncapped and whether Allowances will be sold through Fixed Price Sales rather than auctions.
If Phase 2 and subsequent Phases were uncapped (so that an unlimited number of Allowances is available for Participants to buy each year), it would seem that the need for the secondary market (that is, the trading of Allowances between Participants) and also for the Safety Valve (where allowances from the EU Emissions Trading Scheme are bought by the Administrator and converted into CRC Allowances on the payment of a premium) is considerably reduced.
In this scenario, whether the price of carbon is sufficiently high to encourage Participants to invest in energy efficiency measures or whether they opt simply to buy Allowances (effectively paying a carbon tax on their energy consumption) will depend on the price of Allowances that is set by the government.
It is widely considered that the CCL has failed to provide a price indicator to encourage energy efficiency, so there is a real risk that if the price of Allowances is set too low by the government that the CRC will not achieve its objective of reducing energy consumption and the associated CO2 emissions in energy non-intensive organisations. For more information on the CCL in general, see Practice note, Climate change levy and climate change agreements.
The impact on landlords and tenants of cancelling revenue recycling
The CRC places responsibility for the emissions relating to energy procured by a landlord for its tenants, on the landlord. Consequently, where the landlord procures energy for its tenants, it will have to report on, and surrender Allowances for, the associated CO2 emissions.
A considerable amount of time and energy has been devoted by the property industry over the past two years in considering whether existing leases give landlords the ability to pass through to their tenants the costs they incur under the CRC. For more information, see Legal update, Property industry consultation on apportionment of CRC costs between landlords and tenants: summary of responses.
The general consensus amongst the property industry was that, as the CRC was revenue neutral to the government (that is, not a tax, rate or a levy), the costs associated with the scheme would not be covered by the outgoings or service charges clauses in existing leases which usually refer to rates, taxes or charges payable in respect of the property.
Many landlords had decided not to seek to recoup their CRC costs from their tenants owing to the difficulty in renegotiating the terms of leases and because the costs incurred in doing so could outweigh the net cost of complying with the scheme. Now that the CRC has become a cost to all Participants (that is, now there is no possibility receiving a Revenue Recycling payment that might exceed the costs incurred in participating in the scheme), landlords may be more inclined to try and pass through the cost of Allowances to tenants.
Questions are already being raised as to whether the CRC should now be classified as a tax and, if so, whether the wording in existing leases already permits the pass-through of landlords' CRC costs without any changes being needed to the wording in leases.
Responses to the announcements in the SR 2010
Generally, trade and industry associations expressed surprise and anger at the decision to abandon revenue recycling. The general consensus seems to be that this is a "stealth carbon tax". However, there were some more positive responses to the effect that the change would simplify the scheme and provide a clearer incentive to Participants to invest in energy efficiency measures.
British Property Federation
Liz Pearce, the Chief Executive of the British Property Federation (BPF), said:
"The Coalition said they wanted to simplify the complexities of the CRC and they have certainly found a novel way to do that. This will not however 'remove the burden on businesses' as they claim, but ensure that the CRC will cost the wider business community almost £3.5bn more than it would have. Today's announcement contains little detail on the Government's full intentions in respect of the League Table, how allowances sales will function and to what ends the money gathered will be used. We urge the Government to clarify urgently how the revised Scheme will function, as people are making decisions today upon it."
British Retail Consortium
Stephen Robertson, Director General of the British Retail Consortium (BRC), said:
"We are surprised and dismayed that the £1bn per year participating businesses will put in to the Carbon Reduction Commitment scheme is no longer to be recycled to participants but is instead to be pocketed by the Exchequer...This is a stealth tax on business which not only goes back on the commitments given in developing the scheme but removes a major source of incentives to reduce carbon emissions."
CBI
Richard Lambert, the Director General of the CBI said:
"Businesses that have just signed up to the flagship Carbon Reduction Commitment energy efficiency scheme will be very let down by the Government's unexpected announcement that it will remove the cash-back incentive...A scheme that was meant to change behaviour by encouraging energy efficiency has now become another stealth tax."
Engineering Employers' Federation
Gareth Stace, Head of Climate Change and Environment Policy at the Engineering Employers' Federation (EEF), said he was "completely shocked by the changes to the CRC that were announced in the SR 2010 and "to me it is a tax take to the tune of £1bn in business and very little else". He also said:
"Manufacturers have over the last couple of years, put in place significant and costly strategies to comply with the agreed rules of CRC and aim to work with the recycling of revenue regime. They have signed up to the Carbon Trust Standard, at a cost of £15,000 each... and invested in capital equipment on a return on investment basis linked to the CRC rules. The scheme has started and now government turns the rule book on its head and shatters any strategies organisations have in place. I know that for some manufacturing companies this policy change will cost them over £1m per year...Our members are so dismayed at the announcement that we have today written to Gregory Barker to outline our concerns."
UK Green Building Council
John Alker, Director of Policy and Communications at the UK Green Building Council, said:
"The announcement that government is keeping the money from Carbon Reduction Commitment allowance sales has come out of the blue...It may make the scheme simpler but this is something you've got to consult with industry on before plunging into."
Climate Change Capital
Tim Mockett, Climate Change Property Fund partner at Climate Change Capital, said:
"40 per cent of emissions come from the built environment. This is a bold move by the government to rein this in and put the emphasis on businesses...There are going to be winners and losers, but it's a double whammy for the environment – encouraging industry to improve the energy efficiency of buildings and getting those that don't to fund it."
Trucost
Simon Thomas, Chief Executive of Trucost said:
"at one stroke the UK Government has both simplified the Carbon Reduction Commitment, known as the CRC Energy Efficiency Scheme, and given it teeth...Strengthening the policy to price carbon is likely to greatly help the government meet its target to cut emissions by 34% by 2020. It is also consistent with the broader policy objective of shifting the burden of taxation from 'goods' to 'bads'."
Comment
The announcement about Revenue Recycling payments came as a surprise. Following on from the CCC's report on Phase 2 and the government's comments regarding the need for a review of the scheme, it seemed likely that the government would announce a number of changes to the scheme in respect of Phase 2 and subsequent Phases (rather than Phase 1), and it was generally anticipated that it would take a few months to decide what those changes would be.
Those familiar with the CRC will already have heard various commentators say that the Revenue Recycling payments introduced an unnecessary element of complexity. The CCC's report on Phase 2 included a conclusion that it was not clear if the Revenue Recycling arrangements would actually reward energy efficient firms. The CCC, therefore discussed the possibility of dropping this element of the scheme. It recommended that, in order to assess the option to reform the CRC fundamentally, further evidence regarding the financial incentives provided by the CRC would be needed. It is, therefore, surprising that the government has decided to go ahead this option at this stage. Perhaps the ability to raise £1 billion a year by 2014/15 was too tempting a prospect for a Chancellor facing a deficit of over £150 billion.
PLC agrees that a review of the design of the CRC should be considered alongside a review of the CCL, as a policy landscape crowded with a number of mechanisms doing broadly similar things goes against the principle of better regulation and seems unlikely to achieve the reductions in carbon emissions required under the Climate Change Act 2008.
Chris Huhne, the Secretary of State for Energy and Climate Change, has rejected claims that the removal of revenue recycling payments is a "stealth tax" (see Huhne leaps to defence of surprise carbon tax raid, BusinessGreen.com, 21 October 2010). He said that the change was required to ensure that the scheme is effective at encouraging investment in energy efficiency:
"If you look specifically at the CRC, there was an awful lot of criticism from business of the amount of administration and compliance costs the CRC was imposing, and from our point of view it looked as if it was being imposed with very little effect on carbon reductions...The advice I received was that the impact on carbon reduction was effectively coming from the tax side and not from the very complicated, very baroque system of recycling."
Predictably, the government rejected calls for the revenues from the scheme to be ring-fenced for investment in environmental projects.
The coalition government had previously said it would aim to increase green taxation and this is backed up by Chris Huhne's response to industry complaints about a stealth tax. He said:
"We are obviously going to look at the whole agenda of green taxes because it was in the coalition agreement that we would be raising green taxes as a share of overall taxation...This is not the end of the story; this is the start of the story."
However, he said that he hoped any increase in green taxes would be offset by cuts in other parts of the tax system:
"I hope that what George Osborne has announced will be enough on the taxation side, but that does not mean there can't be a shift in the increase in the proportion of green taxes combined with a reduction in other forms of taxes."