Into the melting pot

Over the next 18 months, government and industry will be exploring an exotic new range of policy instruments to decide how best to deliver the UK's target to reduce CO2 emissions by 20% by 2010. While there may be debate about the ultimate 'mix', industry is acting quickly to keep an energy tax firmly out of the equation.

The political landscape driving UK energy efficiency has changed beyond recognition since the dark days of the oil crisis. What was once a relatively straightforward issue of resource conservation has now become a matter of global preservation, and greenhouse gas reduction is the key.

Up to now, the only significant UK policy instrument to encourage energy efficiency has been the Government’s Energy Efficiency Best Practice Programme (EEBPP), run by ETSU, part of AEA Technology plc. While low energy prices and a slow economy have consistently conspired against the business case for energy efficiency, the Programme has still managed to stimulate some 2.5Mt carbon savings since it started in 1989, mainly through information provision. Now the Programme is actively engaged on behalf of Government to facilitate voluntary and negotiated agreements by industry sectors to reduce emissions.

Voluntary agreements

The chemicals industry was the first sector to sign a non-binding ‘voluntary’ agreement with the Department of Environment, Transport and the Regions (DETR), in November 1997, to cut energy consumption. The Chemical Industries’ Association (CIA) agreed to commit its members – who represent over 80% of the industry’s energy use – to cutting energy consumption per tonne of product by 20% from 1990 levels by 2005. On behalf of the Government, EEBPP will be providing information and advice for the industry over the next three years – including a free five-day audit for 150 SMEs to help them implement best practice – and will also verify industry’s performance in acheiving the objective of the Agreement based on data supplied to the CIA.

The fact that voluntary agreements are a potential avenue to averting an energy tax has not been lost on UK manufacturing industry. Environment Minister Michael Meacher said at the launch of the Government’s Corporate Carbon Dioxide Indicator last year: “We have stressed that the voluntary approach has to be taken seriously, but business has to prove it works, because the alternative…is that government is forced to rely more on regulation, on taxes, or on methods which make some elements of environmental reporting mandatory.”

Negotiated agreements

Using the CIA agreement as a role model, ETSU is now working with 11 more sectors, including steel, rubber, plastics and paper, who want to take voluntary agreements a stage further and make them contractually binding. These so-called negotiated agreements are one of the flexible mechanisms under the Kyoto Protocol. “Industry is looking at negotiated agreements because they want something more positive in return from the Government,” said ETSU’s John Huddleston. Whether this would mean reduced exposure to an energy tax or preferred status under IPPC remains to be seen, but DETR is currently discussing the possiblities with the Treasury.

In the meantime, ETSU is encouraging voluntary agreements as an interim approach. “They start industry thinking about agreements and allow us to start rolling out EEBPP support. We can assess the sort of targets the different sectors can offer and gather the baseline data against which to measure change, should agreement be reached.”

Emissions trading

Emissions trading is another policy instrument which has fired the free-market sensibilities of big business. All eyes are on BP Amoco which went live with its own internal system of trading greenhouse gas emissions on 14 September 1998 (see right).

Economic theory suggests that trading emissions should allow an environmental target to be achieved at least cost to the economy. This is because firms for whom emissions reduction is cheap, can reduce their emissions and sell those emission rights to firms where reductions are more costly. BP Amoco’s view is that trading should be a better way of achieving the world’s objectives than the blunt instruments of command and control regulation which imposes the same standard on everyone, irrespective of the costs they face or taxation.

Solutions for SMEs

Seen by many as part of the long-term solution to reducing emissions, international emissions trading is unlikely to be practical for the majority of small and medium sized enterprises (SMEs) and less intensive energy users who account for around 60% of carbon dioxide emissions from business.

While the pressure is on for all parts of industry to contribute to reducing carbon emissions, the good news for SMEs, according to Dr Nigel Pratten, recent head of EEBPP, is the vast majority of reductions can be achieved using currently available, cost-effective technologies and management practice.

“There is still potential to cut 15-20% of UK industrial energy usage at current prices. Thirty per cent of all consumption is by SMEs and they have done the least amount of work in this area, so it is more likely that 30% reductions are possible here. But even in steel and chemicals, which are the best informed and most engaged industrial sectors, there is scope for 15-20% reductions.”

Industry must act now to beat emissions projections

On published projections, UK emissions of greenhouse gases are likely to be about 7% below the 1990 baseline in 2010 – the middle of the Kyoto commit-ment period of 2008-12. The main reductions in emissions since 1990 have taken place in the energy and business sectors, with the biggest effect coming from fuel switching in electricity supply. After 2000, however, the falling trends are expected to flatten out or reverse.

The fuel switching ‘dividend’ would appear to take the heat off industry in the short term, but a look at future projections indicates that any decision not to act now on energy efficiency will mean much more costly actions will be needed in the future.

Industry is responsible for about 12MtC (or a third) of the 37-38Mt nationally targeted carbon dioxide reductions. Based on current ETSU projections, however, industry will miss the 2010 target by about 3MtC if it adopts a ‘Business as Usual’ approach to energy efficiency. By 2020, the picture looks considerably worse.

If, however, industry adopts what ETSU calls ‘All Cost Effective’ energy saving measures in each sector, it will meet its share of the 2010 targets with a small amount of headroom. Reductions will be eroded with time, however, and by 2020 industry will be just inside the 20% reduction target. And that is assuming it has not been increased by that time.

Full details of industrial emissions projections are available in Industrial Sector Carbon Dioxide Emissions: Database and Model for the UK, ETSU Ref. RYES 18795001/Z/4,1997.

BP Amoco tests trading

When BP Amoco launched its pilot emissions trading system last September, 12 business units were involved. The success of the pilot can be judged by the fact that the company now plans to expand the system to include all 120 company activities.

Emissions trading is just one part of BP Amoco’s portfolio approach to the climate change issue which aims to to deliver the required emissions reductions at least cost. The system has been developed in partnership with the Environmental Defense Fund, a major US-based environmental NGO.

The pilot scheme, which kicked off on 14 September 1998, involved 12 volunteer business units (BUs) from across the three main business streams – exploration, refining and chemicals – from three continents – America, Europe and Australia. Because of the need to make a viable market, only BUs with significant emissions were selected. Together, the BUs account for around 10% of BP Amoco’s total direct emissions.

The pilot group was given a target to cut emissions by 3% compared to a 1995 base by the year 2003. This would put them on track to deliver the Group commitment to cut direct emissions on an equity share basis by 10% compared to 1990 by 2010.

Because of the small scale of the pilot and the possibly ‘thin’ market, it was decided that the allocation of emission rights should be adjusted from a pure historic basis, or ‘grandfather rights’ to reflect an element of future emissions. However, even within BP Amoco, it becase rapidly clear that any move away from an objective historic basis for allocation was controversial, particularly with BUs which had made early investments in emissions reductions.

A small proportion of the emissions permits were held back and retained by the broker, located in BP Amoco’s oil trading arm, to allow them so supply liquidity to the market and catalyse initial trades.

Each BU received a basic allocation of emission rights for 1999 through to 2003 and was obliged to live within that allocation plus or minus purchases or sales of rights.

At the end of any year, each BU has a 60-day period to make sure that it has sufficient permits to cover its emisssions in that year. It it is short it will need to go into market as a distressed buyer. If it fails to cover is needs at the end of the grace period, it will face a fine, at a multiple of the highest permit price in the year. It will also have to buy permits to cover its shortfall to ensure that the environmental objective is delivered.

In keeping with the provisions of the Kyoto Protocol, BUs will be able to bank unused allowances at the end of the year for future use, but they will not be allowed to borrow from future year’s allocations. Banking should promote incentives to overachieve the target early on to build up a cushion against future uncertainty.

Emissions reductions will be externally audited and results will be publically report each year in accordance with the company’s Carbon Dioxide Protocol, its framework and methodology for reporting and calculating emissions from its operations world-wide.

Trading started in earnest on 25 November 1998 when the first trade completed was of 10,000 tonnes @$17 per tonne. To date nearly 40,000 tonnes have been traded (see above). Trades are denominated in carbon dioxide equivalent units, starting with C02, but the company aims to bring in methane and trade it in terms of carbon dioxide equivalents.

According to BP Amoco’s emissions trading spokesman Charles Thomas, the pilot is already bearing out the company’s aim of re-allocating emissions reductions so that they are made at the most cost-effective point. “We’ve seen that trading stimulates innovation on emissions reductions because business units realise that they can create a potential asset. Projects which wouldn’t have gone ahead before, will now make the hurdle.”

In order to set a benchmark to see if trading delivers reductions in a cost-effective way, individual participating BUs will produce costed options for living within the allowance they have been set. This will show the cost of meeting the targets without trading. In addition, the company will be tracking the cost of permits and the number and types of trades to learn more about the process of developing a market in greenhouse gas credits and discover the costs of greenhouse gas abatement across different business types.

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