Waiting to exhale

As part of its obligations under the 1997 Kyoto protocol, the UK is committed to reducing its emissions of greenhouse gases by 12.5 per cent between 2008 and 2012. In addition, the government has an even more demanding national objective of a 20 per cent reduction on 1990 emissions levels by 2010.

A number of administrative and financial instruments have been developed to achieve these goals. They include the climate-change levy and climate-change agreements (CCAs); new policies on renewable energy and combined heat and power; and an emissions trading system. These initiatives are likely to make the cost of energy a more vital part of the strategic agenda, leading to an expanded role for management accountants.

The climate-change levy was introduced into most sectors of UK business in April 2001. It was placed on gas, coal and electricity, and it accounted for 15 per cent of the average electricity price and 12 per cent of the average gas price. Energy from renewable sources and "good quality" combined heat and power systems was exempt from the levy - as was fuel oil, since it was already covered by other taxation arrangements. At the same time, employers' national insurance contributions were reduced from 12.2 per cent to 11.9 per cent to provide compensation for the levy and achieve overall tax neutrality. But the overall cost (or benefit) per employee for a particular company will vary significantly according to the energy-intensity of its processes and its labour productivity.

Companies in designated industries could be exempted from up to 80 per cent of the levy in exchange for CCAs. These agreements specify commitments to meeting targets for savings in carbon dioxide emissions from processes covered by EU controls. Commitments can be expressed in the form of targets of absolute amounts or targets per unit of output. A failure to meet targets leads to the loss of the full exemption from the levy. CCAs were drawn up for 44 industries, some of which were co-ordinated by trade associations. Around 5,000 agreements are currently operating at 13,000 sites.

Companies that have signed these agreements are also eligible to register as CCA participants in the UK emissions trading system to allow those that have "ovcrcomplied" to sell allowances to firms that have failed to comply fully. More than 800 companies have taken up this option so far. The system is voluntary and 32 companies are currently involved as direct participants, including such well-known names as Shell, Tesco and Barclays. There is another scheme under consideration that would allow a broader range of companies to buy and sell allowances without being registered to meet targets, and a framework to raise the number of direct participants is also being developed.

Direct participants either receive incentive payments if they achieve their reduction targets during 2002-07, or they incur financial penalties if they fail. They are allocated allowances relating to their targets during compliance periods and they can engage in emissions trading to meet their targets.

The total incentive payment, which represents reduction targets set by all registered companies multiplied by an incentive price, was set by the government at L215 million. No participant was allowed to bid for more than 20 per cent of the total payment. An incentive price per tonne of carbon dioxide was used as a way for companies to set themselves targets for emission reductions, and was initially derived by means of an auction. This was managed by the Department for Environment, Food and Rural Affairs, and the process is summarised in the table opposite. Repeated cycles of the auction fixed the incentive price at L53.75 per tonne and total reduction targets at around 4 million tonnes, incorporating specified processes not covered by CCAs.

The benefits of joining the emissions trading system include:

* the financial rewards of meeting targets;

* cost reductions resulting from energy efficiency improvements;

* the chance to improve corporate reputation;

* the opportunity to "learn by doing" before the start of emissions trading in the EU.

Although the direct financial consequences for some of the companies in the system are not major because their emission levels are relatively low, one firm has the chance to secure a payment of around L40 million if it hits its target. The opportunities for financial gain are likely to increase as emissions trading goes global through Kyoto protocol mechanisms and the EU emissions trading system.

The BG Group reports that "recent estimates suggest 400 million tonnes of carbon dioxide equivalent will be traded annually by 2010. Estimates of prices vary widely. They are as high as $50 per tonne, but the absence of the US as a buyer reduces likely prices, so a more realistic level of, maybe, $15 pertonne by 2010."

According to a report by Environmental Data Services in May this year, allowances were actually worth less than $5 per tonne of carbon dioxide on the UK emissions trading system (see "Further reading", below).

The EU emissions trading system becomes operational in 2005, although the UK may choose to opt out until 2007. This system will differ fundamentally from the one currently operating in the UK, as it will be compulsory for installations with more than a set thermal capacity or for those conducting specific processes in defined industries. Allowances will be allocated to defined installations to cap their emissions to an absolute target, and participants can then trade these allowances if they want. There is no incentive payment for meeting the target, but there will be a penalty for missing it.

Emissions reduction targets may be met in a variety of ways. Management accountants are likely to be involved in one or more of the following areas:

* Conducting capital investment appraisals of projects leading to emission reductions.

* Costing implications of product redesigns to achieve emission reductions.

* Developing charging systems that motivate managers to reduce energy usage.

* Including financial figures in monthly management accounts that are designed to draw attention to the importance of energy on the strategic agenda.

Decisions on emissions trading also involve complex calculations for which management accountants can offer the required skills. For instance, the decision to engage in trading depends upon whether a company is likely to meet its targets and the relative financial consequences of incentives and penalties, the cost of allowances, the cost of reducing emissions and the longer-term savings from efficiency improvements. And, since allowances are assets that may ultimately be traded by abroad range of companies, financial managers will need to consider the likelihood of changes in their value and the consequent opportunity for wealth creation.

We will shortly be researching these areas on a CIMA-sponsored programme and would therefore like to hear from readers who have experiences that they feel would help institute members to meet the challenges involved.