Government sets out its terms for emissions trading

The Climate Change Levy is not a popular tax.

Ever since it was proposed, companies have argued that it is unwieldy, unfair and ineffective at its stated goal of reducing greenhouse gas emissions. But companies will soon have another option. Starting next year, an emissions trading scheme will allow them to set their own emissions reduction targets, and take advantage of exceeding their targets by selling excess allowances.

The emissions trading scheme (ETS) is, along with the Climate Change Levy, one of the main planks of the UK Climate Change Programme. Although the CCL came into effect first, the ETS has always been part of the plan; emissions trading has been known as an efficient method of reducing greenhouse gas emissions for some years. The Kyoto Protocol features such schemes prominently, and the European Commission has proposed that EU-wide emissions trading should begin in 2005. The UK's scheme is set to start up next year, giving it a three year head start on the European deadline.

Emissions trading is generally far more popular in industry than direct levies, because it sets a group of organisations a target for emissions reduction but then allows the participants to decide a flexible way to meet that target. Each participant can either meet its target by reducing their emissions, exceed their target, and either sell or bank the resulting emissions allowances; or let their emissions remain above their targets, as long as they can buy the requisite number of allowances from other participants.

The guide to the scheme, issued by the Department of the Environment, Food and Rural Affairs (DEFRA), explains that the scheme includes a financial incentive, with a total of £215million available to be spread among companies which agree to take on voluntary targets for a five-year period, 2002-2006.

The participants will have to make absolute reductions - that is, real reductions in total emissions, rather than reduction in emission per unit of production - based on a 1998-2000 baseline. The actual targets, along with the level of incentive payments, will be decided through a competitive bidding process, where the participants will bid in levels of emission reductions at prices set through an auction.

The successful bidders will then have to deliver five equal annual emission reductions to qualify for their incentive payments.

The scheme is also available to companies which already have emissions or energy efficiency targets set through Climate Change Agreements (CCAs) which were signed to secure rebates from the Climate Change Levy.

They will have access to emissions trading to either help them meet their targets or to sell allowance if they exceed their goal. However, as most of these agreements were on a relative basis - that is, in emissions per unit produced - there will be restrictions placed on the way these companies can trade allowances, and there will be a 'gateway' system to control the flow of allowances from this sector. Companies which do not want to set emissions targets can also participate by opening an account at the registry to buy and sell allowances, but these firms - along with those already involved in Climate Change Agreements - will not receive any incentive payments.

'Trading emissions allowances is no different from trading in any other commodity,' says DEFRA. 'Anyone who holds an account in the registry will be able to buy and sell allowances. Participants in the scheme will be able to trade directly between themselves or through third party brokers.'

The emissions covered by the scheme include both direct emissions (those produced by the actual process on site) and indirect emissions, which take account of the greenhouse gases released in generating the power used on the site. Participants will be responsible for measuring and reporting their baseline emissions, although these, and any reductions, will be checked by third-party inspectors. Emissions credits will only be awarded after reductions have been verified.

The scheme also comes complete with penalties. According to the DEFRA guide, these will 'ensure that it is always preferable for participants to buy their allowances rather than miss their targets.' The penalties will be 'sufficiently strong to ensure that the scheme operates effectively, but are not disproportionate for a voluntary scheme.' Moreover, the participants who received incentives will have to pay these back, with interest, if they fail to meet their stated emissions targets, and will face tougher targets in future years to make up the shortfall.

Environment minister Michael Meacher believes that the climate change programme 'could cut greenhouse gas emissions to 23 per cent below 1990 levels by 2010.' The scheme 'builds on the success of recent climate change talks in Bonn by demonstrating that tackling climate change can be good for business,' he says.