CRC: An industry decision

By now, few should be unaware of the Carbon Reduction Commitment Energy Efficiency Scheme (CRC) and most will have an understanding of how it works. CRC, like any new law demanding behavioural change, presents a challenge. How will the property industry respond?

Before Christmas, the BPF launched Consultation on the treatment of the CRC in the context of Landlord and Tenant Relationships to see if some industry consensus can be reached. The BPF’s consultation asks the question: “should tenants contribute proportionately towards CRC costs incurred by their landlords?” The natural response to this simple question belies significant complexity.

Devil in the detail
CRC applies to corporate groups, not buildings or any other asset class. Meeting the challenge of attributing costs between buildings and/or tenants requires an understanding of the types of cost that can be incurred.

A landlord within the scheme will have CRC responsibility for energy consumed in any building he lets where he manages common parts or common services or on-sells energy to his tenants. He will also be responsible for energy he is deemed to have consumed elsewhere. The costs that he can incur fall into three classes: (i) the gap between buying carbon credits and recycling payments received; (ii) the administration cost of complying with the scheme; and (iii) information gathering.  

Net carbon costs are the most problematic and the least well understood. Contrary to what many people believe, it is not the case that the amount spent buying carbon allowances can differ from the amount received in recycling payments by no more than 10 percent in the first recycling year, 20 percent in the second year and so on up to 50 percent in year five. This both significantly under estimates the potential gap and overlooks significant influences on the size of the gap.

The volume of carbon allowances required depends on the amount of energy consumed. The price paid depends on how effective is the CRC participant’s trading strategy. Yet, the size of the recycling payment is largely unrelated to either the volume of carbon bought or the price paid for allowances.

Instead, the recycling payment represents a share of a recycling pot. This is determined by year one emissions and does not change for the rest of the phase. The size of the pot (so what each share is worth) depends on how much the Government raised selling allowances though its sales or auctions. 

That share’s value is then adjusted depending on league table position (which depends on how the year-on-year change in total emissions of each participant relates to that of every other). The precise outcome is unpredictable and will be significantly distorted by acquisitions and disposals of assets or members of the corporate group or other investments made.

It is possible that if a CRC landlord increases its portfolio significantly then, even if becomes more energy efficient, a net carbon purchase-recycling loss could be made every year for the whole of the phase. Conversely, a CRC landlord disposing of assets or making deep cuts in energy consumption in one year of a phase, could make a significant net gain for the rest of the phase, regardless of subsequent league table performance.

Most other costs connected with scheme compliance are not incurred in respect of any particular building but rather in respect of the position of entire CRC group. They will be little affected by the specific levels of energy consumption anywhere within the group or in any particular letting and are only incurred because a particular landlord is a CRC participant. Another landlord might fall outside the CRC and not incur any such costs.

Information gathering costs are probably the least problematic. The cost incurred gathering data in respect of a particular building and even particular tenant should be capable of being quantified. This task is, in any event, a necessary part of proper building management so most, if not all, of the associated cost should be recoverable under typical service charge provisions

Other relevant factors
This entire discussion has also to take place in the context of the reality of building energy consumption. Reducing the amount of energy consumed in a building requires: (i) greater efficiency of the built structure and services; (ii) a reduction in energy consumed by appliances; and/or (iii) other behavioural change. The extent to which control over these lies with landlord or tenant will vary depending upon building and lease terms.

The options
There are three ways to potentially tackle CRC. The first is for the landlord to deal with all CRC compliance requirements and costs/gains as an internal matter. This reflects the view that the CRC is more like a corporate tax (or relates to dealing with the landlord’s interest in the property and other assets).  In consequence the landlord will manage energy efficiency across his CRC group and property and other interests. Depending on lease terms, there may be energy saving measures, such as replacing boilers with efficient ones, with the costs or recovered from his tenants.  However, ability to control tenant behaviour may be very limited.

The second option, to pass through to tenants in new leases, is not difficult.  However, it is a rather different matter coming up with a fair way of attributing costs between tenants when so much of what determines whether there is a net cost or a net gain is outside of a tenant’s control. A tenant achieving a significant reduction in energy consumption would expect to be rewarded,
yet the CRC in no way guarantees that.

It is difficult to reconcile the fact that the identity of the landlord – whether they are a CRC participant or not – determines whether or not there will be any CRC costs or gains to deal with. There is also the risk that if action is taken which is out of step with the industry generally, this will have a negative impact on rental value.

The third option is a scheme within a scheme. This could address any or all of the following: budgets for buying; carbon allowances; receipt of recycling payments; the cost of energy efficiency measures; and savings realised in energy spend. If the scheme is intended to address CRC costs and gains but be revenue neutral for the landlord, this means artificially creating a new risk of a net gain or loss for tenants. In the current market, tenants are unlikely to find this attractive. Conversely, if intended to be revenue neutral for tenants (or even positive, to provide an incentive), the landlord will have to subsidise this.  

If the scheme focuses on energy savings, it has the potential to benefit both landlord and tenant. Energy savings reduces the landlord’s need to buy carbon allowances and, if significant, may also improve its league table position. For tenants, energy savings mean much greater, real and predictable costs savings.

However, if a variety of schemes emerge, property sales may become complicated as a building’s buyer and seller may perform very differently within CRC. This may substantially change the risk profile for both incoming landlord and existing tenants. Any schemes adopted will need to be able to adapt.

In each case, unless an approach is entirely benign or positive for tenants, establishing and maintaining a ‘market norm’ is important if developing practice is not to impact adversely on rental value. Readers are urged to respond to the BPF consultation bearing this article in mind.

Tom Bainbridge and Rhodri Pazzi-Axworthy are partners at law firm Nabarro LLP