DECC consultation on the form and content of new Climate Change Agreements

In 2001, the Government introduced the Climate Change Levy (“CCL”). This tax on energy supplied to the non-domestic sector was introduced with a view to reducing energy demand and greenhouse gas emissions. The CCL applies to all energy-intensive industries such as agriculture, manufacturing, food & drink, textiles, construction, energy and engineering.

At the same time, in order to offset some of the CCL’s competitive disadvantage to those industries, the Government introduced Climate Change Agreements (“CCAs”). Under the CCAs, those eligible industries that meet tough energy efficiency and carbon emission reduction targets benefit from an 80% reduction in the CCL.

CCAs are negotiated between the Department of Energy and Climate Change (“DECC”) and industry. They set out the terms of companies' emissions targets and their ability to claim the CCL. Applicable throughout the UK, the CCA scheme comprises 52 industrial sectors and approximately 10,000 facilities, grouped into 5,000 target units. To date, ten major energy intensive sectors (aluminium, cement, ceramics, chemicals, food & drink, foundries, glass, non-ferrous metals, paper, and steel) and over thirty smaller sectors have entered into CCAs.

Recently DECC issued a consultation paper in which it makes proposals and asks for industry members’ views on the form and content of the new CCA scheme which will replace the current scheme upon its expiration in March 2013.

The main aims of DECC’s proposals are to:
1) extend the CCA scheme to 2017;
2) simplify the CCAs; and
3) align the CCAs with the European Union's Emissions Trading Scheme (“ETS”).

Absolute or relative targets?

In its consultation, DECC proposes various changes to the terms of the current CCAs. However, the key question is whether carbon emissions targets should be set on an absolute or a relative basis. Under the current scheme, the overwhelming majority of target units and sectors have relative targets. However, most other climate change instruments such as the Carbon Reduction Commitment and ETS have absolute caps. In addition, Carbon Budgets under the Climate Change Act will set binding limits on UK greenhouse gas emissions. The Government is therefore keen to introduce absolute targets which would mean setting targets at a fixed level of energy use or emissions as opposed to per unit of throughput (which allows for an element of growth within the target). It believes that this approach is a necessary step towards meeting carbon budgets and ensuring compatibility with future phases of the ETS.

Issues

Some important issues to be considered include in the debate surrounding the choice between absolute and relative targets include: 1) whether, compared with relative targets, absolute targets reduce flexibility or restrict growth and 2) whether absolute targets are harder to meet than relative targets. DECC’s answers to these legitimate concerns for industry fall squarely on the side of absolute targets, stating early on in its consultation that it believes that relative targets cannot achieve its goal of guaranteeing reductions in emissions.

In response to issue 1), DECC highlights that businesses with absolute targets will usually have to purchase additional allowances upon expansion, whereas businesses with relative targets will generally have to purchase allowances when they are in decline. As relative targets become more difficult for certain industry sectors to meet in these challenging economic times, they will likely have to consider investing in allowances, at a time when they are possibly not in the best financial position to do so. While this argument highlights the attractiveness of absolute targets in the current climate, businesses would do well to consider their plans in the longer term when responding to the consultation.

DECC’s response to issue 2) focuses on the fact that the difficulty of a target is dependent on two factors, namely, its form (i.e. relative or absolute) and the level at which it is set. Although DECC does not directly answer the question, in stating that the form of a target will be taken into consideration when sector associations negotiate their CCAs with DECC, it implies that DECC may be open to negotiating comparatively lower target levels in the case of absolute targets.

Other proposals

De minimis & materiality thresholds

Under the current CCA scheme, there are no provisions for de minimis or materiality thresholds with respect to targets. This means that where a business fails to meet its target or purchase the required allowances, it is decertified and barred from claiming the 80% CCL discount for two years, or until the following target period. No force majeure provision applies to any failure to meet these requirements. The Government has therefore become over-burdened with the administrative costs relating to complaints concerning decertification from the scheme, and recertification.

To combat this, DECC has proposed the introduction of a de minimis provision which would apply to any failure to meet targets by up to 1%. As the de minimis provision would only apply to very limited failures to meet targets, DECC has also proposed a materiality provision which would apply to any failure to meet targets that is greater than 1% of the target but no more than 2% of the target. Both the de minimis and materiality provisions would require the purchase and retirement of the shortfall of allowances within ten working days of notification by DECC. In addition, the materiality provision would require the payment of £80 for each allowance in the shortfall beyond the 1% target. This should be a welcome proposal for businesses that have in the past fallen short of their targets due to administrative oversights.

Alignment with the ETS

Other proposed changes would see the CCAs brought into line with the ETS. CCAs cover direct (fossil fuel) and indirect (electricity) emissions and some process emissions, whereas ETS covers direct and process emissions. As a result, for some organisations there is an overlap in terms of direct and process emissions. Where both the CCA and the ETS emissions targets apply to an organisation DECC proposes to avoid any double-counting by splitting ETS emissions from the CCA target.

Eligibility and cost of CCAs

It should be noted that DECC does not propose to alter the eligibility criteria for CCAs. Also, the consultation does not deal with target levels as this will be negotiated with sector associations once the form and content of the new CCAs have been agreed. The Government is considering passing on the administrative costs of the CCAs by introducing a charging scheme. However, any such scheme will not be introduced before DECC’s prior consultation on a detailed proposal.

Conclusion

Companies within energy-intensive industries, such as those mentioned in this article, will be affected by the new CCA scheme. They may therefore wish to contact their industry sector association in order to engage in this consultation before it ends on 4 June 2009. For a copy of the DECC Consultation on the Form and Content of New Climate Change Agreements please click here.