Everything you ever wanted to know about the CRC, but were afraid to ask

I'm not sure who I feel more sorry for: the civil servants who have spent years trying to keep everyone happy while producing the Carbon Reduction Commitment Energy Efficiency (CRCEE) scheme or the organisations that now have to try and comply with it.

As one of those civil servants somewhat wryly observed ahead of today's launch of the scheme's finalised version, it has been designed to strike a balance between simplicity and fairness and sadly, those two characteristics are rarely complementary.

Through three lengthy consultation processes, business groups have highlighted so many real and perceived injustices within the scheme that an initiative that started out as a relatively simple cap-and-trade scheme designed to provide large users of energy with an incentive to improve energy efficiency has evolved into a labyrinthine scheme with more caveats and jargon than an entire party conference season.

Nothing highlights the complexity of the scheme better than the fact it has now changed name three times. It started life in 2006 as the Energy Performance Commitment, before someone in Whitehall decided climate change was more exciting than energy efficiency and changed the name to the Carbon Reduction Commitment. Cue much wailing and gnashing of teeth from the renewable energy sector, which not unreasonably pointed out that the name did not make sense as the scheme fails to recognise energy generated by renewable sources and therefore only gives firms incentives to improve energy efficiency rather than invest in zero-carbon energy generation. As a result, we now have the Carbon Reduction Commitment Energy Efficiency Scheme (should that be Crikey for short), which is marginally more accurate but significantly more long winded.

The final version of the scheme is certainly fairer than it was, but as one of the journalists attending the government's briefing on the legislation was heard to observe: "Help me out here, I actually have to try to explain this to people."

So how do you explain it to people, particularly when a recent survey showed that more than half of firms remain unaware of the regulation? And what should organisations do to ensure they comply?

The first thing to understand is that there is no need to panic – it is not as complex as it first seems. The government has repeatedly toyed with the edges of the scheme, but the foundations remain basically the same: it is a cap-and-trade scheme designed to punish organisations that fail to improve their energy efficiency and reward those that do. If you put in place measures to report on your energy use and identify means of improving your energy efficiency – all of which is little more than best practice anyway – you will not go far wrong.

Unfortunately, once you get into the nuts and bolts of the scheme, things become rapidly more complex.

The initial three-year introductory phase kicks off from April 2010, when any organisation with half-hourly electricity meters – an estimated 20,000 – will have to register with the Environment Agency. For about 15,000 firms that is it – they will not have to do anything more until the second phase of the scheme in 2013 when they will be required to re-register. However, the anticipated 5,000 hotels, hospitals, banks, supermarkets and other large consumers of power that use more than 6,000MWh of electricity a year will immediately qualify for the scheme and become fully fledged participants in the CRCEE.

As such, they will be legally obliged to start measuring their energy use in readiness for April 2011 when the scheme really kicks in. At that point, those participating organisations will be required to calculate their carbon emissions for 2010/2011 using a government-approved methodology that assumes all the electricity they used had a carbon footprint equivalent to the grid average. They will then report on their carbon emissions to the Environment Agency.

In the same month, the government will begin the sale of CRCEE carbon allowances at a set price of £12 per tonne. Participating organisations will be required to purchase sufficient allowances to cover their anticipated emissions during the second year of the scheme, although because there is no cap on the number of allowances sold during the first phase of the scheme, they can return to the government and shell out for extra allowances if necessary.

According to government calculations, the £12-a-tonne price means that an organisation using the minimum 6,000MWh of energy each year, equivalent to an energy bill of about £500,000, will have to pay an additional £48,000 in allowances. Environmental consultancy WSP Energy and Environment estimated that the average participant will see a 12 per cent increase in its energy costs as a result of the first full year of the scheme.

However, as the scheme has been designed to be "revenue neutral", participants should only be out of pocket for six months. In October 2011 the second part of the scheme begins when the government publishes its first league table based on the performance of participating organisations.

In theory, this should be the simple part. The original intention was to rank organisations based on the extent to which they had improved their energy efficiency and reduced their energy use in the past year, but that obviously would not work for the first year of operation as there was no data with which to compare it. Moreover, some of those businesses that had already invested heavily in energy-efficiency measures complained that they would be penalised in the league table for their early action, while those laggards that waited for the CRCEE to come into effect before undertaking simple energy-efficiency measures would appear to have performed better.

As a result, the government hit on something called the Early Action Metric, which will be used to determine an organisation's position in the first league table in October 2011 and will contribute to their position in the second and third league tables alongside their energy performance. Organisations can get a good score in the Early Action Metric by installing automated energy meters and qualifying for the Carbon Trust Standard, which requires them to deliver reductions in carbon emissions over the previous two years. So the 100 firms that have now qualified for the Carbon Trust Standard can expect to be in the running for the top spot in October 2011.

The final placings in the league table are of significance for financial as well as reputational reasons. Just like the Premier League, there is money as well as glory to be had from finishing near the top. Under the rules of the scheme, organisations will receive back the money they spent on allowances in April, but the worst performers will face a 10 per cent penalty charge, while the organisations at the top of the table will receive a 10 per cent bonus. The fines and bonuses escalate each year, with organisations ultimately facing penalties worth 50 per cent of their total outlay by the fifth year of the scheme. In theory, the smallest company in the scheme shelling out £48,000 on allowances will face a fine of £24,000 if it is among the worst performers in 2016.

As mentioned earlier, this league table does not recognise if an organisation has sourced its energy from zero-carbon renewable sources, so in a failed attempt to appease the renewable energy lobby, the government has said it will produce a separate league table detailing how much power an organisation generates from onsite renewables.

For its part, the Renewable Energy Association (REA) remains unimpressed by this compromise and is pushing for the government to account for zero-carbon energy in the main league table, providing firms with a further financial incentive to invest in onsite renewables.

"As the financial impact of the CRC becomes more significant, companies stand to take a significant financial hit for investing in renewables by having to pay for emissions that they have not in fact emitted," explains Gaynor Hartnell, chief policy officer at the REA. "Given the hugely challenging renewable energy target we face and the examples of exceptional renewable energy leadership from the commercial sector that need to be built upon, this is an astonishing outcome. Industry deserves a carbon league table in which renewable energy investment by the commercial sector is actively given incentives and duly rewarded."

Officials at DECC remain unmoved, insisting that the existing Renewables Obligation and soon-to-be-introduced Clean Energy Cash Back feed-in tariff scheme already provide financial incentives for investment in onsite renewables, while the new table will ensure that organisation's investment in renewables is recognised publicly.

So there we have it, that's phase one covered.

Phase two begins in April 2013, and it all gets more complicated still. At this point, the government will take advice from the independent Committee on Climate Change and cap the number of allowances in the system. Participants will then have to take part in a blind auction, bidding for however many allowances they want at a series of prices before receiving allowances at the clearing price.

As a result, all participants will essentially have to undertake a cost analysis for various energy-efficiency measures and work out which projects they can undertake for less than the price of allowances. The cap on allowances is likely to leave some organisations short as the date approaches in April 2014 when they have to surrender the previous year's allowances to the Environment Agency. They will be forced to trade allowances through an online clearing house, bidding to buy them from organisations that have cut their energy use and no longer need them.

It is at this point that the financial pressure for firms to curb their energy use will really start to bite. Not only will they be at risk of financial and reputational penalties each autumn if they perform badly in the league table, they will also have to buy extra allowances if they fail to cut energy use in line with the cap.

There is little doubt that the CRCEE is onerous and complex, and several organisations have already voiced concern about the potential scale of the cost and regulatory burden.

But it is worth remembering where the motivation for the scheme came from. As one DECC official observed, organisations have been talking for years about energy efficiency, but with a few notable exceptions they have done very little about it. Businesses did not want a carbon tax, so this is the chosen mechanism for forcing them to make changes that are already in their best interest but have been ignored by boardrooms for too long.

The CRCEE may be demanding, but there will be plenty of winners as well as losers from the new scheme as those companies that make the greatest effort to curb energy use reap the financial rewards. According to government estimates, by 2020 the scheme will have cut carbon emissions by 4.4 megatonnes and saved participants £1bn a year in reduced energy bills.

If you don't like the prospect of penalty charges and increased energy costs, the answer is simple: get on with cutting your energy use.