CRC grows up into a real tax

CRC is now a real tax

The UK Carbon Reduction Commitment has grown up into a real tax. Previously much of the money paid for allowances was to be paid back, however the government has now announced that the revenue recycling part of the scheme is to be scrapped. They estimate that the Treasury will now gain somewhere in the region of £1bn per year by retaining the money from the sale of CRC allowances to qualifying organisations. Given the current state of the UK government finances and spending reviews the reasons for this are fairly obvious.

The good news is that the complex and badly structured revenue recycling scheme is gone and now there will be no cross subsidy of other participant organisations through the scheme. This greatly reduces the financial risk of the scheme as predicting your CRC cost now only requires you to forecast your energy consumption.  The need to buy a supercomputer to model the league table to forecast your recycling payment from your league table performance is now gone.

The bad news is that this is now a direct tax on energy consumption for qualifying organisations. At £10 - £15 per tonne CO2 allowance and 1 tonne of CO2 equating to roughly 500 kWh of grid electricity this creates an additional power cost of around 10% on top of your power bill (between £0.005 and £0.008 per kWh).

This change to CRC will, in combination with the already high cost of electricity in the UK, cause some operators to build new facilities in other countries instead, impacting on the development of the UK ‘digital economy’,  which the Government tells us will create employment.

This article makes no statement about whether global warming exists or whether taxing energy to reduce consumption is a good idea, those are policy matters. What this article will discuss is the implementation of the CRC and the likely effects on the UK data centre industry.

For several years now the UK government has been planning a scheme to regulate CO2 for organisations using more than a certain amount of energy. The scheme is the UK approach to meeting a European commitment binding states to reduce their CO2 emissions. The Carbon Reduction Commitment as it is called has been somewhat controversial since the first consultation and there has been substantial resistance to the increased cost and complexity to UK businesses. 

The CRC was presented as being a simple incentive programme that would create a pressure on ‘qualifying’ UK organisations to reduce their energy consumption (the qualification threshold equates to roughly 700kW of continuous utility draw). The particularly controversial part that was simultaneously touted by the government as their major defence of the scheme and objected to by others as its greatest complexity and weakness was “revenue recycling”.

Purchasing allowances and revenue recycling
The scheme requires organisations lucky enough to qualify for the CRC to estimate their energy use for the following year and purchase allowances for the CO2 that energy use equated to. A series of simple conversions are provided to allow different energy sources to be converted into kg CO2. 

The cost of these allowances was then going to be returned to the companies in the scheme based on both their share of the overall CO2 in the baseline year and a league table of their relative performance. These revenue recycling payments were supposed to deliver two key benefits of the CRC;

  1. Firstly the scheme would not be a tax, all of the income raised from the sale of allowances (less the administration costs) would be paid back to the participants in the scheme
  2. Secondly the recycling payments would vary dependent upon how well each company performed in the CRC league table, this was supposed to deliver a financial reward to those who improved their efficiency the most and a penalty to those who improved least

The problem was that the league table, although it had relatively simple rules created a very complex game in which would have been almost impossible to predict the performance of your organisation and therefore your cost under the CRC. This fundamentally undermined the stated goal of the CRC by creating a series of perverse incentives, penalising energy efficient growing companies whilst rewarding their less efficient competition and making it more difficult to create business cases for energy efficiency measures through increased uncertainty in the cost.

Carbon laundering opportunities
An additional major issue was that CRC failed to capture any carbon your organisation was responsible for but had managed to put on the other side of a service contract. For example the electricity and gas used by an office building owned by your organisation would have been included in your cost and affected your league table position whilst exactly the same building once sold to a landlord and leased back would apply the landlord instead.

With the actual cost of the carbon allowances mitigated by the recycling payments one of the stronger levers of the CRC was the public “name and shame” league table of performance which would be published annually. Many organisations with valuable brands were keen to perform well on this league table.

League table
The league table has not (yet) been scrapped and it appears that it may well retain its role in threatening the brand value of large qualifying organisations. This is a serious ongoing problem with the CRC, it will be believed, quite incorrectly, by many individuals and no doubt poorly informed organisations that the position of a brand name on CRC league table provides a comparison or index of the environmental performance or energy efficiency of that organisation. This could not be further from the truth, any organisation which substantially grows will be penalised by the league table, even if they grow by taking business from less energy efficient competitors. The league table does not and will not show how “green” an organisation or any individual product or service from an organisation is and cannot be rationally used as a procurement tool. The league table is simply a list of how well different organisations managed to play the CRC reporting and laundering game.
Data centre impact
This change in the recycling payments will clearly have a substantial impact on the UK data centre sector. No longer is CRC simply a complex regulatory burden that will cost a lot of money in compliance and reporting. It is now an expensive tax as well. A medium sized colo data centre can expect to add £500,000 to its annual opex for the purchase of allowances in addition to the compliance costs.

There are clear impacts to the data centre market. Colo providers are now likely to have to add a direct “CRC tax” to customer power bills as metered power times a multiplier. Those service providers whose contracts do not allow them to pass on such new charges face a more difficult decision, with power cost as the major part of their cost of delivery the 10% increase will substantially reduce and possibly eliminate their margins.

Impact on the UK
This change to CRC will, in combination with the already high cost of electricity in the UK, cause some operators to build new facilities in other countries instead. This is likely to be particularly true for outsourcers and “cloud” providers who are able to deliver services from remote data centres with little overhead. This could become a serious problem for the UK in several ways:

We have already off-shored the carbon of manufacturing goods (not reduced, just displaced). Now we are set to offshore some of the carbon of running ICT services. The electricity grids in many of the likely countries to gain these outsourced facilities have substantially higher carbon intensity than the UK which may actually increase the overall CO2 emissions, thus defeating the stated objective.

Displacement to other territories will put data centre CO2 beyond the regulatory control of UK government, impacting not just the ability to tax the carbon but also data protection legislation. It is not feasible to place any import tax on ICT services to counter this as there is no useful intensity measure.

Displacement of data centres to other countries will inevitably impact the benefit to the UK from the “digital economy”. Instead of leading the development and delivery of new technologies and services that generate service and IP exports, this displacement drives the UK toward being a consumer and importer of such new developments. External investment into the UK is particularly likely to suffer from this effect. Cloud operators have already demonstrated that they will go to substantial lengths to take 10% off their energy bill even selecting the country of deployment for cheap (coal fired and high carbon) grid electricity or to enable the data centre to run with free cooling only.

The reformed CRC presents a very direct incentive for organisations to outsource their data centres and then allow the outsourcer to migrate them offshore to escape the effective cost of UK electricity. How much of this actually occurs will be an interesting experiment.

Impact on the rest of the world
Many other countries are planning regulation of data centre energy consumption or efficiency. Those countries will be watching the impact of CRC on the UK economy and data centre industry closely, both to determine whether it acutally improves efficiency or reduces energy consumption and to understand what the economic impact it. They will then have to make a determination of how much economic impact they think the energy reduction is worth.