How will the Carbon Reduction Committment affect IT outsourcing?

Government plans to cut carbon emissions in the UK will soon be mandatory for large businesses and public sector bodies. An immediate consequence will be...

Government plans to cut carbon emissions in the UK will soon be mandatory for large businesses and public sector bodies. An immediate consequence will be changes to the contract terms and pricing mechanics of large IT projects, write Bridget Fleetwood, partner at international law firm Pinsent Masons, and Nicolette Walshe, sustainability and climate change consultant at Logica.

The Carbon Reduction Commitment Energy Efficiency Scheme (CRC) comes into force on 1 April. Last year, Intellect, the IT sector trade body, warned that the scheme would encourage transfers of carbon liability, rather than encouraging a net overall reduction in emissions across the UK.

Intellect criticised the league table at the heart of the CRC, which rates the best and worst performing organisations based on the rise or fall in their carbon emissions. Intellect, in common with other industry bodies, pointed out that its focus on absolute reductions in carbon consumption makes little sense for an industry in growth and that incentives should focus instead on the relative reductions that can be achieved despite overall growth.

We expect that any review of the metrics used within the league table will be an exercise in fine-tuning, not significant reform. The CRC regime is here to stay and we anticipate that there will be no legislative overhauls in the short to medium term, notwithstanding the imminent General Election.

Some suppliers believe they are being driven to transfer their carbon consumption offshore. Data centres, for example, might be built in more polluter-friendly countries to avoid having their carbon emissions attributed to their UK operators.

However, while the CRC is an initiative of Westminster, not Brussels, we anticipate that other countries' laws will catch up. An offshore strategy is more likely to succeed if it is driven by factors like cost and choice of climate (ie, a location that demands less artificial cooling) rather than choice of regulation.

In the absence of legislative change, prudent suppliers may be reviewing their contracts.

Where ICT outsourcing relationships are already in place, the service delivery arrangements may be set in stone and the contracts may have many years to run. The arrangements may dictate that the services are delivered in a way which is not environmentally friendly; that energy-hungry facilities are used to deliver services; that dedicated rather than virtualised servers must be used. In many deals, the customer will have agreed to pay a fixed price for the services - with no incentive to move to an arrangement which reduces energy consumption or the supplier's utility costs.

In these situations the supplier can try to negotiate with the customer to introduce more environmentally-friendly provisions. Some customers, particularly those in the public sector, will welcome 'greener' contracts and may agree to changes that offer no commercial upside. But if the changes mean an increase in the customer's costs or an exposure to fluctuating prices, most customers will refuse. Suppliers will also be looking to renegotiate their energy contracts to introduce flexibility wherever possible to reduce some of their exposure under the new legislation.

Those suppliers whose contracts allow for re-negotiation and/or price increases caused by changes in law are in a more attractive position and the outcome will be directed by each contract's wording and commercial allocation of risk. However, under many government contracts the CRC will not trigger price renegotiation clauses because the scheme will be classified as a 'general' change in law - which does not allow for special treatment.

For new ICT outsourcing contracts yet to be placed, we expect suppliers to address the new environmental regime as part of their negotiations with customers.

In these new contracts, suppliers will introduce differential pricing to incentivise more energy-efficient service solutions and to drive new behaviours within the customer organisation to reduce, for example, data processing transactions or the supplier's reliance on cooling mechanisms in data centres.

We may also see a new focus on contract review clauses triggered by a change in cost base. These are common in areas of market volatility, such as commodity service components, and may be used more frequently in future in the area of utility costs.

We expect to see more outsourcing deals with pricing structures which allow the suppliers to pass on their utility costs in full to the associated customer - or to treat them as 'direct supply' to the customer with the bill being paid through the agency of the supplier. This sounds simple but the question of pricing utility costs so that they can be accurately allocated and passed on to any specific customer is not straightforward in the new world of caps, market pricing for allowances, bonuses and penalties.

If suppliers are using fixed prices in the area of data centre operations, there may need to be a significant contingency within the price to allow for the future unknowns in the energy pricing market.

We may also see suppliers 'mirroring' the scheme in individual contracts to allow them to flow through to customers the regime imposed by the CRC. Such negotiations will be a challenge: neither supplier nor customer will want to carry the risk and responsibility that each regards as the other's problem.

The direction of environmental regulation is unavoidable and unambiguous even if it is not universal. The CRC is an important part of the UK's regime and it may be tweaked but its core principles are unlikely to change. The CRC is not in force until April, but its principles can be reflected in IT contracts today.

This was last published in February 2010

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