The 13th Edge Debate: 7th November 2001

Bright Eyed and Bushy Tailed

Paul Ruyssevelt, Director, Energy for Sustainable Development Ltd

Introduction to the Scheme

Emissions trading was introduced under the Kyoto Protocol as a flexible mechanism for achieving reductions in greenhouse gas emissions. Emissions trading offers organisations one of the most cost-effective and efficient means to reduce emissions through the marketplace. Since greenhouse gas emissions take effect globally, the location of reductions does not matter, so long as they occur. This makes reducing greenhouse gas emissions well suited to a trading-based approach, enabling emissions reductions to take place where they are most economic.

The UK Government intends to establish a UK Emissions Trading Scheme (ETS) as a key component of its Climate Change programme and has committed £215m to fund incentives for the scheme over the first five years from 2002 to 2006. The target is to reduce UK emissions by 7.7mtCO2 equivalent through the ETS in its first five years of operation which is the same level of reduction as is expected from the impact of the Climate Change Levy. This scheme will be amongst the first to be established throughout the world.

The ETS is due to start in April 2002, while the deadline for organisations intending to register an intention to participate is the end of December 2001. All UK based legal entities will be entitled to enter the ETS. While the scheme is voluntary in the first instance, it is expected that the Government will move towards a mandatory scheme at some point in the future. Thus participation in this pilot phase of the ETS offers an opportunity to prepare for a possible mandatory scheme, gain early experience of emissions trading markets, and the ability to take advantage of incentives to get a head start against competitors in reducing greenhouse gas emissions.

The framework for the UK ETS has been developed over the last two years by the Emissions Trading Group, an organisation set up by the CBI, working closely with the Government's Department for the Environment, Food and Rural Affairs (DEFRA). The ETG comprises representatives from large corporations, power generators, accountants, sustainable energy companies, government departments, environmental NGOs and others. The process of consultation has been highly constructive and the resulting framework goes a long way to encourage wide participation in the scheme.

The UK Emissions Trading Scheme will work by encouraging a number of businesses and other organisations to take on absolute emissions caps, in return for financial incentives paid on the basis of each tonne of CO2 reduced against a baseline. An organisations' baseline will be defined as the average of its greenhouse gas (or CO2) emissions over the period from 1998-2000. An organisation can select to enter the ETS on the basis of all greenhouse gas emissions or just CO2 only. Ongoing targets will only apply to emissions sources identified in the baseline (while new sources, such as new buildings, will not be included).

Financial benefits of joining the ETS

Once an organisation has established its baseline, and had this approved by the Government (DEFRA), it will be eligible to bid for financial incentives via an auction process due to take place in January 2002. Participants will bid for a given quantity of CO2 reduction at a given level of financial incentive. The auction will be a dynamic auction based on the "descending clock" auction model. Thus an opening price for the incentive will be set and participants encouraged to bid in a certain level of emissions reductions. The price will then gradually be lowered until the total level of emissions reductions bid into the scheme, multiplied by the price of financial incentive, is equal to the total funds available. This will then establish a "clearing price" for the financial incentive, which all participants will receive upon proof of compliance with their target. Thus participants will effectively set their own target based on what they can afford to reduce.

It is expected that the value of the financial incentives offered by government (and allocated via an auction process in January 2002) will be around £20-30 per tonne CO2 (reduced against the baseline emissions). These incentives provide an extra form of income that can be added to the significant savings in energy costs that will achieved by the implementing emissions reduction measures.

Non-financial benefits

As well as the financial incentives, the additional benefits of being involved in the Emissions Trading Scheme include:

• Early experience of carbon markets ahead of competitors
• Reduction in emissions in advance of further government policies to tackle climate change on the business sector
• Positive PR from being one of the first companies to be involved with the ETS
• Good political message sent to government (helping to build the case for a trading-based approach rather than an energy/carbon tax)

It is perhaps these other, non-financial benefits of joining the scheme which present the greater opportunity than the financial incentives themselves.

Lower risk routes of entry to the ETS

The alternative to engaging in the Emissions Trading Scheme on the basis of an absolute cap is to participate on the basis of:

project-activity only (selling carbon credits from particular emissions-savings projects into the ETS market), or
by pooling emissions from certain parts of the property portfolio into a trust with other emissions/companies which can be separately managed, and thus independently access financial incentives.

Both of these options are lower-risk routes of entry which can still bring some of the non-financial benefits of association with the ETS.

Emissions Trading and Buildings

Since some 50% of UK CO2 emissions derive from buildings the design, construction and management of buildings must play an important role in reducing overall CO2 emissions. Unfortunately, emissions reductions from dwellings have been excluded from the UK ETS because the domestic sector is the primary target for the Energy Efficiency Commitment placed upon UK energy supply companies. However, supply companies that exceed their targets under this Commitment will be able to trade the resulting extra emissions reductions as within the ETS.

Emissions reductions from non-domestic buildings are eligible to be traded within the UK ETS and could form the basis on which large property owning organisations enter the scheme. Emissions reductions of the order of 20% are often easily achievable in such buildings through low or no cost measures that could be readily implemented. Hence significant opportunities exist to benefit from both the financial value of the energy savings and the value of the incentives available within the ETS. The clearest opportunities are available to owner occupiers who will benefit from both, but rewards could also be available to landlords and tenants who are able to enter in mutually beneficial agreements.

As well as existing buildings, new building projects could generate emissions reductions that could be traded in the UK ETS in the future through the 'project-activity' referred to earlier. In such cases it will be necessary to demonstrate that reductions have been made in relation to a 'business as usual' baseline.

For property owners and developers and their design teams to decide whether or not the UK ETS could provide positive benefits requires a careful examination of the costs of entry, the risks of non-achievement of targets and the financial and other rewards available. These issues will be examined during the debate.