Quietly and without much fanfare, the Government released its Green Paper on the Emissions Reduction Fund (Green Paper) just before Christmas.1 The Emissions Reduction Fund (ERF) is the central plank of the Government's Direct Action Plan, which also includes the One Million Solar Roofs and 20 Million Trees programmes and the Solar Towns and Solar Schools initiatives.
The aim of the Direct Action Plan is to achieve emissions reductions of five per cent based on 2000 levels by 2020. On current emissions projections, this target represents a reduction amount of 131 million tonnes of CO2-e in 2020 and a cumulative amount between 2014 and 2020 of 431 million tonnes.2
For an overview of the Direct Action Plan and the ERF please refer to our previous legal update which can be found here.
The Green Paper follows a Terms of Reference document which was released for public consultation on 16 October 2013.
Submissions on the Green Paper are due by 21 February 2014. A White Paper is foreshadowed to be released in "early 2014" and we anticipate that any legislation required to implement the ERF will be released in draft with the White Paper.
The key aspects of the Green Paper, which are set out in more detail below, are:
- The ERF will commence on 1 July 2014.
- The ERF will primarily be implemented through the existing Carbon Farming Initiative (CFI) infrastructure.
- The administrator of the ERF will be the Clean Energy Regulator (CER), who will run the ERF auction process and enter into contracts with successful applicants.
- The emissions reductions covered by the ERF will include facility based reductions as well as specific activities or projects (as is currently the case under the CFI).
- Emissions reductions activities will need to be "new" (it is not currently clear what the relevant date will be for making this assessment, but it is assumed it may be 1 July 2014).
- Purchase contracts for the emissions reductions will be limited to a five year duration and are likely to include "make good" provisions for under delivery.
- Existing CFI projects may bid into the ERF auctions, with success determined on price of the bid.
- The CER will set a benchmark price (i.e. maximum price it would pay per tonne of emissions reductions), which would be kept confidential.
- The "mechanism" to ensure businesses do not exceed their "business as usual" emissions (i.e. baseline) has now been renamed the "safeguard mechanism" and is unlikely to take effect until after 1 July 2015 (there is no longer any reference to the word "penalties" and the Green Paper talks about "compliance options" in the event that baselines are exceeded).
- The ERF will be reviewed in late 2015 and the findings of the review are likely to feed into consideration of the post 2020 policy framework (whether this timing will work given the likely timing of international arrangements remains to be seen).
ERF administration and implementation
As previously anticipated, the Green Paper confirms that the ERF will be developed by expanding and building on the CFI. It is intended to be implemented and administered by the CER. The existing National Greenhouse and Energy Reporting Scheme (NGERS) will be the primary tool to implement the safeguard mechanism and this too will be administered by the CER.
The CER's role would include:
- approving projects;
- registering participants and administering auctions;
- entering into contracts for purchase of abatement;
- managing the reporting and verification processes;
- issuing Australian Carbon Credit Units (ACCUs) for certified emissions reductions; and
- making payments on delivery of emissions reductions.
It currently performs this role under the CFI for project approval, reporting and verification and issuance of ACCUs.
It is further proposed that the Domestic Offsets Integrity Committee (DOIC) will continue to advise on whether proposed emission reduction methods meet integrity requirements and the DOIC will be expanded to reflect the broader coverage under the ERF.
It is intended that the ERF will commence on 1 July 2014, and a review of the ERF will be undertaken towards the end of 2015. The timing of this review may conflict with Australia's international obligations under the United Nations Framework Convention on Climate Change, which may require a post 2020 target to be determined by the first quarter of 2015.
Types of emissions reductions
The premise underlying the ERF is to source the lowest cost form of abatement to reach the Government's emissions reduction target of 5 per cent.
The broad categories of abatement sources identified in the Green Paper include:
- Energy efficiency
- Fuel switching
- Capture of waste coal mine gas
- Commercial building upgrades and clean power technologies, such as co-generation or tri-generation
- Land sector
- Landfill gas capture and waste diversion
Only activities which are new3, not required by law or do not receive funding from other government programmes (e.g. the Renewable Energy Target, state based energy efficiency schemes) will be eligible.
However, some activities which participate in government programmes, such as reforestation which is undertaken under an employment program or energy efficiency activities sponsored through an environmental upgrade agreement may not be excluded.
Crediting emissions reductions
"Emissions reduction methods" will provide the rules necessary to identify, measure, audit and verify emission reduction projects that are eligible to be purchased through the ERF. Of note, the method will determine which activities can participate in the ERF (this is different to the current process under the CFI, which sets out eligible project types on a "positive list").
In the interests of efficiency and expediency, the Government plans to base the development of emissions reduction methods on the CFI methodology development and approval process, however the intention will be to streamline the process currently in place under the CFI as follows:
- focus on large-scale emissions reduction opportunities;
- simplify methods and where possible, incorporate models and processes used in the National Inventory;
- reduce public consultation on the emissions reduction methods from 40 days to 28 days; and
- release the emissions reduction methods for consultation in their final form, rather than an earlier version, as currently happens under the CFI.
The DOIC will continue to assess the proposed emission reduction methods and we assume that the methods will still need to be made into a legislative instrument approved by the Minister.
Once emission reductions have been verified under the appropriate method, the CER will issue ACCUs, as currently happens under the CFI.
Types of emissions reduction methods
The Government proposes two categories of methods: activity methods and facility methods. Emissions reduction providers can elect which method they use.
Activity methods will apply to "specific emissions reduction actions". These methods could be modelled on and adapted from current international methods (such as those under the Clean Development Mechanism) or a combination of methods. The Government's preference appears to favour fewer methods with broad application than multiple methods for the same activity, in order to reduce transaction and administrative costs.
Facility methods will cover all emissions reduction activities at a particular facility. For example, activities such as fuel switching, optimising boiler efficiency and recovery of waste heat.
Facility methods would be established and supported by NGERS data in order to measure reductions relative to "past practices". The implication of the link to using NGERS data is that new entrants or facilities undergoing major expansion in capacity would not be able to use these types of methods. Neither would any facilities not currently reporting under NGERS.
Two aspects which will require resolution are: how the starting point is identified (i.e. what comprises the "past practices") and how additionality is treated over time (for example, periodically re-setting the "starting point").
Purchasing emissions reductions
As the Government has previously made clear, the ERF will purchase emissions reductions using a reverse auction process based on the cost per tonne and the quantity of emissions reductions bid into the auction. The Green Paper makes it clear that the sole objective of the ERF is to purchase the lowest-cost emissions reductions and to this end, a "pay-as-bid" model is proposed. There is no reference to the possibility of "banding", as had been suggested in a number of submissions to the Terms of Reference.
Only bids that satisfy "prequalification requirements" including participant checks (such as a "fit and proper person" test), project eligibility, commercial readiness and reliability of reduction estimates will be considered. The Government is considering a minimum bid size which could reduce administrative costs and incentivise aggregation. A maximum bid size aimed at reducing the influence of larger participants in auction results is not favoured at this time as it could restrict the bidding of "large, viable and low-cost projects".
The Government proposes that, initially, businesses can submit bids at any time and the CER will organise tender rounds at regular intervals in which it selects bids based on a predetermined confidential benchmark price, which would act as a price ceiling. A more formal auction process, potentially occurring several times a year, would be adopted once the emissions reductions supply is well established.
The Government is currently considering further design features of the auction process, such as the content of auction bids, the format for auctions (the preference seems to be for "sealed bids"), the setting of the benchmark price, whether a budget should be set for each auction, and the auction schedule. It is likely that the CER will be given a significant amount of discretion over the auction design, particularly as to funding constraints for individual auctions, the auction schedule and whether to proceed with the "pay-as-bid" model.
Once bids have been selected, the CER will enter into standard form contracts with the emission reduction provider which will specify the agreed price, quantity and delivery time for the ACCUs. The intent is that standard form contracts will promote fairness, transparency and efficiency and should lower transaction costs. It will be a prerequisite before being allowed to participate in the auction process to agree to the standard contractual terms.
For successful bidders of existing CFI projects which have already generated ACCUs, payment should take place shortly after the auction. For new projects, a forward contract will be entered into. Preconditions of these contracts may include the securing of project finance or any necessary regulatory approvals within a specified timeframe.
The Government has indicated that these contracts will have a maximum term of five years, notwithstanding any longer crediting period which attaches to the project (for example, emissions avoidance projects under the CFI currently have a crediting period of seven years). Any ACCUs generated after this five year period could potentially be bid into a subsequent auction or sold into the voluntary market.
The standard form contract will be drafted to incentivise delivery of the contracted amount of emissions reductions. However, if delivery is not satisfied, the contract is likely to contain "make-good" provisions such as replacing ACCUs from an alternative project or paying the additional costs of the CER purchasing replacement emissions reductions.
Safeguarding emissions reductions
What was initially referred to as the "penalty" aspect of the ERF has now been coined a "safeguard" mechanism.
The Green Paper states that the ERF is "designed to allow businesses to continue ordinary operations without penalty", with the intention being that the ERF will encourage businesses to reduce their historical business-as-usual emissions. However, it is recognised that a mechanism is needed to provide business with incentives not to exceed historical emissions baselines.
At this stage, the safeguard mechanism is still substantially undeveloped. The Green Paper suggests that it will commence from 1 July 2015 and could apply to a proportion of facilities currently reporting under NGERS.
There are a number of design elements that the Government is seeking feedback on.
The Government has suggested that it may be appropriate to cover both Scope 1 (direct emissions) and Scope 2 emissions (indirect emissions, such as electricity use), provided that there was no double counting of the Scope 2 emissions.
It is not clear whether the current NGERS facility threshold of 25,000 tonnes CO2-e would be used, or a higher threshold such as 100,000 tonnes of CO2-e would apply. It is noted that a higher threshold would significantly streamline coverage, by limiting the number of covered entities to around 190 (the current number of liable entities under the Carbon Pricing Mechanism is around 370).
The setting of baselines is probably the most difficult aspect of the Government's Direct Action Plan and it would appear that this is a primary reason as to why implementation of the safeguard mechanism has been delayed until 2015. Baselines can be set based on emissions intensity or on absolute emissions levels. Issues such as the historical period which should be used, the impact of external events and the treatment of expansion in production capacity at a facility will all need to be resolved.
At this point in time, the Government has clearly stated that no revenue is to be collected under the safeguard mechanism. This includes a situation of non-compliance with the baseline. Instead the Government is proposing flexible compliance arrangements.
Options suggested in the Green Paper include an initial grace period when the baseline is introduced to allow entities to establish processes and invest in emissions reductions projects before any compliance action would apply. Another suggestion is that an entity could average its compliance over multiple years as long as the average emissions are below the baseline for the total compliance period. It was also proposed that entities could purchase emissions reductions credits or international units to offset any emissions exceeding their baseline.
The Government supports new investment and significant expansion of business, however, it presents challenges as baselines determined according to historical data (such as that collected under NGERS) are not possible. To overcome this, the Green Paper suggests that baselines could be based on an industry average or determined by what is considered "best practice", acknowledging that there are challenges associated with determining best practice for setting facility-level baselines and for new industries not currently operating within Australia.
Changes to the Carbon Farming Initiative
Existing CFI projects will continue to be eligible to generate ACCUs before and after the ERF is implemented. These ACCUs can either be surrendered/sold under the Carbon Pricing Mechanism (until February 2015), or sold into the ERF (from 1 July 2014, with success determined on the price of the bid).
The 22 existing methodology determinations under the CFI will continue and new projects can be approved under these methodology determinations even after the ERF is implemented. The Government is committed to approving new CFI methodology determinations "until the ERF is implemented" and will focus on four "priority areas" (in essence these are similar to the current list of methodology proposals before the DOIC).4
After 1 July 2014, the Government will develop new land-based "emissions reduction methods".
Other relevant changes to the CFI include:
- abolishing the positive list and addressing additionality through the use of the emissions reduction methods;
- for carbon sequestration projects, only requiring a project aggregator to demonstrate that they have the agreement of landholders to take part in a project (rather than requiring them to have a proprietary interest in the project area);
- for carbon sequestration projects, introducing a 25 year permanency option instead of the current 100 year permanence requirement (under this option the number of ACCUs issued would be reasonably discounted to reflect the reduced period);
- applying risk-based criteria to determine how often a project's offsets report would have to be independently audited; and
- allowing projects to have a shorter reporting period of six months.
As mentioned above, submissions may be lodged until 21 February 2014. If you would like any assistance in preparing a submission, please contact a member of our Climate Change Team.
We are aware that work has already commenced on preparation of emissions reduction methods for certain sectors. Please let us know if you require any further information about the priority sectors, or would like to play a role in development of these methods. We would highly recommend participation in the development of these methods if you are wishing to bid projects into the ERF.
In due course, we would be happy to provide advice on the prequalification requirements for participating in the ERF auctions or initial tender process, and the steps required to achieve project approval and issuance of ACCUs.
1The 61 pages of the Green Paper is to be contrasted with the 158 pages of the former Government's Clean Energy Plan policy document and the 532 pages of the Carbon Pollution Reduction Scheme Green Paper.
2It should be noted that the figure of 431 Mt CO2-e takes account of the fact that Australia is able to carry over Kyoto Protocol units from the first commitment period (2008-2012) into the second commitment period (2013-2020) of 121 Mt of CO2-e
3It is not entirely clear but it is assumed that existing projects or activities in place as at 1 July 2014, when the ERF is due to commence, will not be able to participate in the ERF (with the exception of existing CFI projects).
4These are increasing soil carbon; reduction of livestock emissions; expanding opportunities for environmental and carbon sink plantings; and reforestation and deforestation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.