UK cap-and-trade could impose penalties of just £4,000 on big emitters

The government has defended its plans for a new carbon trading mechanism for large energy users such as supermarkets, hotels and government departments, after it confirmed that under the scheme the financial penalties and incentives designed to encourage firms to curb their energy use could amount to just a few thousand pounds.

Under the planned Carbon Reduction Commitment legislation, around 5,000 organisations whose annual half-hourly metered electricity use, and 70 kilowatt metered electricity use in Northern Ireland, is above 6,000 MWh – which roughly equates to an energy bill of over £500,000 – will be obliged to enter the cap-and-trade scheme.

According to the government's response to consultation published last week, from 2010 firms will be required to purchase allowances, initially at a set price of £12 per tonne, in correspondence to the cap on emissions levels imposed on them by Defra. Firms that then exceed their emissions cap will have to buy in extra credits to cover excess emissions before surrendering their credits back to Defra at the end of each year, while those that come in under their cap will be able to sell their unused credits.

Firms will then have the money raised through the initial sale of credits returned to them, but in an attempt to further incentivise organisations to reduce energy use the money that is returned will be adjusted to include a bonus or penalty payment based on how firms have performed in a CRC league table that will track participants' emission reduction efforts. The proportion of initial payments returned to participants as a bonus or taken as a penalty will increase over time, starting at 10 per cent for the first year and rising year-on-year up to year five when the worst performing firms could lose as much as 50 per cent of their initial payment.

The government said that the aim of the scheme is to get firms to focus more on investing in energy efficiency and provide a greater financial incentive for them to curb energy use.

However, according to Defra calculations a typical firm entering the scheme and using 6,000MW of energy a year at a cost of around £500,000 will be responsible for 3,138 tonnes of carbon emissions and will have to buy £37,656 worth of carbon credits at the initial £12 a tonne rate.

Firms with greater energy use will have to pay more, while those organisations that fail to curb carbon emissions will face extra costs throughout the year as they are forced to buy in extra carbon allowances. The cost to firms that fail to cut energy use is also expected to rise from 2013 when the credits will be sold at auction and bonus payments and penalty charges will become more significant.

However, under the current penalty and bonus proposals the worst performing firm in Defra's new CRC league table during the first year of the scheme's operation could pay as little as £3,756 in penalty charges, while the best performing firm could receive an equally modest bonus representing less than one per cent of their £500,000 energy bill and providing limited extra financial incentive for them to cut energy use.

A spokesman for Defra rejected the suggestion that the relatively modest sums involved will undermine the effectiveness of the scheme, adding that the government expected the CRC to deliver carbon savings of four million tonnes a year. "The scheme is based on the simple business rule that what gets measured gets done," he explained. "It is intended as a way of getting businesses to take a look at their electricity bills on a regular basis."