Australia: Kyoto’s Legacy

In December 1997, 160 nations reached an agreement to reduce greenhouse gas emissions by consolidating the forces of the global market place and sovereign regulation to protect the environment. The Kyoto Protocol requires industrialised nations referred to as ‘Annexure 1 countries’ to reduce their average national emissions by 5% below 1990 levels over the period 2008 to 2012.

By virtue of different demographic population bases and industrial activities, a second group of countries was given emission reduction targets in excess of their 1990 levels, a good example being Australia which is required to achieve emission levels at 108% of its 1990 level.

Although a number of countries have signed the agreement, the Protocol will not come into force until at least 55 countries, representing 55% of developed countries emitting greenhouse gases, ratify the Protocol.

To date, the US has not ratified the Protocol and without the involvement of the US, it is unlikely that the Protocol will come into effect. However, legislation has been submitted to the US Congress which would give parties credits for emission reducing actions prior to the international regime coming into effect.

Although there is doubt as to whether the Protocol will come into effect, various developed countries have adopted programs and policies that reduce greenhouse gas emissions on the domestic front.

The Danish Government has plans for a cap and trade emission trading system for their power generating sector to commence, by a phased in approach, from the year 2000. This system operates on the basis that for every tonne of carbon dioxide (CO2) power generators omit above their cap, a US$6 penalty will apply.

The Sir Colin Marshall inquiry into emissions trading has been accepted by the British Government which has announced plans to introduce a ‘Climate Change Levy’ in 2001 to reduce emissions by 25%. Energy intensive industries will pay a climate change levy, or alternatively, participate in an emissions trading system thereby reducing the levy applying to their operations. Although the system is still subject to negotiation between Ministers and business leaders in relation to target levels, the British Government believes proceeds of the levy (which in reality is a tax) would raise approximately £1.75 billion pounds in its first year.

The New Zealand Government has been monitoring the British model closely and is considering a pilot emission trading scheme prior to implementing a national emission trading program. The philosophy of the New Zealand model follows the US where industry believe emission trading is the best way to achieve environmental goals at the least cost to industry.

The Commonwealth Government has developed a national greenhouse strategy announced by the Prime Minister in November 1997 titled, Safeguarding the Future: Australia’s Response to Climate Change. At this stage the Australian Greenhouse Office (AGO) has released two discussion papers for assessing options available in achieving emission reduction targets. The papers canvass schemes including trading in renewable energy permits, emission trading, and the role of forests as carbon sinks, to help reduce emissions.

The 1997 Prime Ministerial Statement on Climate Change issued a target of 2% use of renewable energy fuels for electricity supply. The implementation of the 2% target extends to electricity retailers, other large buyers, and wholesale generators who will all be liable for sourcing an additional 2% of their electricity from renewable energy or specified waste-product energy sources by 2010.

New South Wales has been making positive progress under a number of renewable energy programs. In 1995, the Sustainable Energy Development Authority of New South Wales (SEDA) was established for the purpose of reducing levels of greenhouse gas emissions by investing in commercialisation and use of sustainable energy technologies, such as renewable energy, energy efficiency and cogeneration.

The green power schemes allow electricity consumers to purchase electricity produced from renewable energy sources such as solar photovoltaic, wind, biomass, and hydro-electric power, by paying the price that it costs to generate the electricity. The schemes operate generally at a premium which in addition to paying for the supply of electricity may also provide capital for investment in renewable energy schemes.

The Australian Greenhouse Office in June released the second of four discussion papers on National Emissions Trading. There are various ways emissions trading can be implemented.

One scheme involves allocation of greenhouse gases on a country by country basis which can then be divided into shares that are allotted to each industry participant emitting greenhouse gases. Each industry participant would receive a permit to emit certain amounts of greenhouse gases, thus allowing these permits to be bought and sold.

The two ways of allotting the permits are referred to as ‘Grandfathering’ or ‘Auctioning’. Grandfathering relies on a system where industry participants are granted permits for their actual emissions. Industry participants that find they cannot reduce emissions below their target could then buy extra permits to increase their emissions, or alternatively sell those they do not require if they can achieve emission reductions.

‘Auctioning’ involves permits being sold in the market place according to the highest price. A disadvantage to industry involved in the ‘auctioning’ system stems from the additional cost imposed to operate where before no such cost occurred. Accordingly, the auctioning system will be difficult to impose on industry, however if grandfathering is utilised, there is the risk that industry will have no incentive to meet the Kyoto target.

Other mechanisms contemplated by the Kyoto Protocol in assisting participating countries to reduce their emissions are:

1. Greenhouse Gas Emission Trading;

2. Carbon Sinks – where revegetation and tree planting create a sink capacity for absorbing carbon dioxide emissions from the atmosphere; and

3. Clean Development Mechanism - which enables developed countries to participate in co-operative project activities in developing countries to reduce greenhouse gas emissions.

The critical consideration arising from the early introduction of a trading scheme is the disadvantage that some sectors of Australian industry would suffer in comparison to international competitors who are not saddled with these additional costs of operation.

Government, therefore, needs to be careful in their timing of the introduction of emission trading to ensure additional costs are not imposed on Australian industry. Secondly, if an emissions trading scheme is established, that overseas interests do not buy up Australian permits leaving local industry short.

There are, however, significant inducements for Australia to enter into an early emission trading scheme, as ABARE (Australian Bureau of Agricultural and Resource Economics) predicts the cost of Australia meeting its Kyoto target could be reduced by 20% with international trading in emissions.

There have been significant investments to date in emission trading schemes, such as the Suncor-Niagara Mohawk emissions trade.

In 1998, Suncor Energy Inc (a Canadian based energy company) entered into an agreement with Niagara Mohawk Power Corp (a US utility company) to acquire 100 000 metric tonnes of greenhouse gas emissions.

Under the agreement, Suncor has an option to buy up to an additional 10 million tonnes of reductions over a 10 year period. In addition to this, Suncor will earn the recognition of the credits involved. The scheme has the potential value of 10 million Canadian dollars.

Greenhouse gas emissions will be reduced as Niagara Mohawk switches from coal to natural gas and undertakes renewable energy projects. Niagara Mohawk are contractually obligated to reinvest at least 70% of the proceeds of the sales of the emissions to further greenhouse gas reductions.

This transaction was effected even though the earning of carbon credits is not authorised under current Canadian or US law.

Forests are carbon sinks which remove and store carbon dioxide from the atmosphere. These sinks can be incorporated into an emissions reduction trading system by allocating credits for the amount of carbon that is sequestered (stored in plants and other vegetation). If an emission trading system was developed, plantation operators would be able to sell these credits.

At a recent conference David Brand, Executive General Manager of State Forests New South Wales, stated that only Australia and New Zealand have significant new forests on land previously utilised for other purposes prior to 1990 (the Kyoto emissions ‘baseline’). Carbon sinks will only contribute a small percentage to overall global targets for greenhouse gas reduction, however, they could be significant in Australia and the South Pacific.

The commercial application for carbon sinks involves stakeholders of forests selling their associated carbon rights to industries who are greenhouse gas emitters, to allow industries to offset their greenhouse gas emissions.

• The New South Wales Government in conjunction with Bankers Trust, have approved a private sector investment opportunity for new planted forests. The project is designed to raise $30 million in the first 12 months and is believed to be a Kyoto compatible forestry carbon offset entitlement.
• New South Wales State Forests are understood to have also undertaken transactions with Pacific Power and Delta Power.
• Tokyo Electric Power is also understood to be investing in up to 40,000 hectares of New South Wales State Forests prior to 2010 whilst BP Amoco is working with the Department of Conservation and Land Management in Western Australia to reforest farm land to offset emissions from its Kwinana operation.

• In the South West Pacific, the United States Conservation Group, and the US Conservancy, are in discussion with the PNG Forest Authority for a US$5 million to US$7 million project covering
• 230 000 acres in the Josephstaal Forest. This involves reducing the impact logging on the site and creating permanent conservation areas to safeguard biodiversity and rare forest species.
• The US Conservancy has been active in a considerable number of South American countries including Belize, Ecuador, the Dominican Republic, Guatemala, Colombia, and Mexico in sequestration projects involving investments of US$40 million.
• Closer to Australia, Trexler & Associates Inc (a consultancy and broking company with utility companies in the US) and Counterpart International, have been approaching the Papua New Guinea Forest Authority and PNG Office of the Environment and Conservation on the possibility of trading carbon rights for cash.
• It is understood that Compac, a US company, had an agreement with PNG landowners involving an investment of US$2 million in an exchange for conserving 12 000 hectares of forest. Unfortunately for the investors, the landowners reneged on the deal and allowed the forest area to be logged because of the huge royalty benefits flowing to the landowners from logging.

The greatest hurdle for investing in third world carbon sinks involves persuading stakeholders to pursue this revenue raising option rather than undertaking logging.

The question for Australian industry is whether they should be involved at this early stage in identifying carbon sinks in our nearest neighbours and traditional markets before these resources are ‘locked up’ by our international competitors. This question is more pressing given Australia’s high rate of greenhouse gas emission per capita of population.

There are many legal issues involved in trading carbon rights arising from forest sequestration including:

• Identification of parties owning the carbon rights as distinct from property interests in the land or the trees;
• Standards for assessment and verification of carbon sequestration in different forests and locations;
• The legal status of carbon credits and their transferability between parties; and
• Registration of ownership of carbon rights.
• Interestingly, in this environment of regulatory uncertainty, it has recently been reported that the Sydney Futures Exchange (SFE) has signed a memorandum of understanding with the New South Wales State Forests Department to develop the world’s first exchange trading market for carbon sequestration credits. It is expected that trading in these credits will commence around the middle of the year 2000. The proposed carbon trading market would be open to all interested participants, from small landowners through to large forestry companies. The commodity that will be traded in such an exchange will be in units of carbon sequestered by ‘Kyoto Consistent Forests’. The unit for trade would be defined as one metric tonne of carbon dioxide equivalent emissions. A Kyoto consistent forest is defined as a forest planted after 1 January 1990, that is managed by human activity, and results in a land use change.

This is a significant development for Australia, as Australia’s history of land clearing indicates a need for increased vegetation cover. The SFE scheme will be an added incentive to the various programs promoting sustainable management of rural lands and forests, which hopefully will reduce land clearing. Over 20% of Australia’s greenhouse gas emissions have been attributed to land clearing activities, whereas land use change to developing forestry functions as sinks for emissions under the SFE system, provides stakeholders with an economic return.

The New South Wales Carbon Rights Legislation Amendment Act 1998 allows for carbon sequestration agreements to be recorded as covenants on the certificate of title.

Such assistance, which is regarded as a world first, allows gas emission permit holders to identify whether the landowner has rights to this carbon sequestration and whether there are any third party security interests relating thereto.

An established carbon trading market on the Sydney Futures Exchange would provide the following benefits:

• A mechanism for governments and companies to proactively manage their emission risks before the Kyoto Protocol is implemented. Positions can be taken in the market at a price and quantity prior to the Kyoto Protocol’s first commitment period 2008 to 2012;
• Provide early price discovery to inform companies making investments and decision making, whether on the domestic front or internationally; and
• As these prices are international and the system is designed to be transparent, companies will be able to more effectively facilitate their long term planning.
• Sydney Futures Exchange is taking a leading position in this developing market which some analysts predict could quickly rise to US$700 billion.

In relation to carbon sinks, Gadens are advising an international merchant bank on option documentation for capturing carbon rights in forests in the South West Pacific, including the raising of North American capital on the NASDAQ listing board in Vancouver, Canada. It is a 200 000 hectare project that will apply selective logging and reafforestation within Kyoto consistent forest requirements.

Gadens Lawyers also act for a major Australian publicly listed company with large scale forest concerns.

This publication is provided by Gadens Lawyers to its clients and correspondents on a complimentary basis. It represents a brief summary of the law applicable in New South Wales as at March 1999 and should not be relied on as a definitive or complete statement of the relevant laws.