ETS – in or out?
A proactive approach can reduce carbon as a liability and potentially turn it into an asset, according to Rupert Edwards, CEO of Climate Change Markets
Now is the time to start thinking about emissions trading scheme-related decisions, such as potentially opting out of the EU scheme and, instead of participating in Phase 1, complying with Climate Change Agreements. Many companies, however, will decide to participate in the EU emissions trading scheme – and these companies can benefit financially from active involvement.
Understanding how the EU ETS works will be especially important for those sectors where the major production costs are energy and capital. Many heavy energy users consider that further energy efficiency gains will be hard, making CO2 reductions difficult to achieve and increasing the need for a well thought-out approach to the ETS.
However, it should be possible for some of the costs of compliance to be passed on to consumers in some sectors and allowances can be treated as an asset on the balance sheet with some potential for lowering capital costs.
The EU ETS
The basic requirements of the EU ETS scheme are that each company involved will be allocated a fixed amount of allowances, each one equivalent to one tonne of CO2 emitted. Should these companies emit less than the allocated amount then they will be able to sell their excess allowances into the market.
However, should they fail to reduce their CO2 emissions, then they will need to purchase allowances from companies which have made successful emissions cuts. By March 2006 and the conclusion of the first year of trading, companies will have met their reductions or bought credits from elsewhere, or face very large fines and a continued need to comply with the legislation.
Opt out decision
Article 27 in the European directive stipulates that if a company can prove that it can reduce emissions through another mechanism, equivalent to the amount it could reduce through the EU ETS, then the company should, in theory, be able to opt out. This option is only available for Phase 1.
Many industry associations are creating Climate Change Agreements in which members can participate, and which will introduce measures to lower emissions.
Installation level allocations from most EU Member States will be known by October, and the final EC decision for the UK on the opt-out for Climate Change Agreements from the EU ETS will be known at the beginning of November.
The UK government is working to achieve an opt-out for all CCAs which also have an EU ETS obligation. Although the final decision should now be known – it was due at the beginning of November – this still means companies have less than a month to decide to opt out of Phase 1 of the EU emissions trading scheme.
Making the decision
Several considerations need to be taken into account when making the decision to opt out. Most importantly, annual additional reporting and verification procedures will be necessary to ensure that the measures undertaken within the CCA have equivalency with the EU ETS. These will have to be undertaken yearly, and will entail additional costs.
Companies will also need to consider the impact of the grouping of the company within a new sub-sector, the CCA, within their overall industry sector. Furthermore, if a company chooses not to participate in phase 1 it will face a steeper financial learning curve when it has to comply with the EU ETS in phase 2.
It may be better to join now and get familiar with the EU procedures as soon as possible. On the other hand, joining a CCA can enable companies to negotiate an 80% reduction in their Climate Change Levy.
There are also some important issues to consider should your company decide to remain in the EU ETS. Firstly, it is important to ensure that the allocation EUAs (EU Allowances) will adequately cover your company’s projected CO2 emissions. Furthermore, your company will lose the Climate Change Levy discount available on membership of a Climate Change Agreement.
Consider the risks
Come the first week of November 2004, UK companies will need to have made the decision to stay in or opt out. The EC has made every indication that the 1 January 2005 start date is firm, so now is the time to find out just how the scheme will affect the bottom line.
The current price for one tonne of CO2 is around e8.75 but there is potential for considerable volatility in the market due to changes in coal and gas prices, the weather and economic growth. Companies will need to consider these risks and devise a risk management strategy, which might include, for example, purchasing allowances forward if the cost is lower than the energy efficiency investment.
Look to the future
Companies will also need to plan for the longer-term. From 2008 the allocation of allowances will certainly be tighter and the price higher. Energy efficiency investment may be the best long-term alternative and could free up a surplus of allowances, thus generating an asset.
Companies can also consider using allowances as collateral to reduce their borrowing costs and can even earn some income from lending allowances out for a fixed period and fee.
Complex and quick decisions need to be taken in the next few months and in a highly competitive industry, whether in the EU or UK ETS, it is important to form a strategy early to minimise the cost of new regulatory burdens and try and turn them to your company’s best advantage.
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