Australia: It's a pig of a task - designing the Abbott government's Emissions Reduction Fund

One of the toughest challenges in designing the Abbott government's Emissions Reduction Fund is to determine where to draw the line – what companies and what activities should be rewarded with taxpayer funded contracts. And it becomes particularly problematic when government administrative decisions on valuable property rights and government contracts can be subject to legal challenge.

Under Direct Action, companies are able to be rewarded for genuine and additional emissions reductions. But this raises the questions of how to determine whether reductions have actually occurred and then whether they are actually additional.

The Green Paper proposes that the rules for companies to calculate and verify emissions reductions from different activities will be set out in emissions reduction methods. These methods will either be activity-based or facility based. These methodologies will be in a similar form to those currently required under the Carbon Farming Initiative for land sector abatement.

The first challenge is to identify in the methodology the point from which a decrease in a company's emissions is measured – otherwise known as the baseline. Confusingly, the Green Paper proposes the use of two different kinds of baselines – absolute emissions based and emissions intensity based. Either may be used depending on the type of emission reduction activity proposed. In addition, separately, when it comes to determining when companies should be penalised under a "safeguard mechanism" from 2015 it suggests an emissions intensity baseline.

Absolute emission baselines – business as usual levels – are easy to calculate but production changes and unforseen events can result in companies exceeding that baseline. As a result, the Green Paper proposes the option of calculating baselines by averaging companies' emissions – as reported under the National Greenhouse and Energy Reporting Scheme – over the last five years.

Emission intensity (how much is emitted per unit of production) baselines are much more difficult to calculate but can appear attractive as historically companies have become more energy efficient over time. However, in some cases, such as coal mining, production can become more energy intensive and energy intensity can also increase due to lower production. Such baselines are hard to determine where goods have a number of components each with their own manufacturing process and energy input. Energy intensity baselines were used to determine emissions intensive trade exposed companies' entitlement to financial assistance under the Clean Energy Future scheme and took over two years to determine.

The next part of the challenge is to determine whether companies' efforts to reduce emissions on a project are genuinely "additional" when compared to their business as usual effort. This concept of "additionality" is difficult to define and the definition has consequences for which companies can be rewarded.

If a company already has a proposal on its book to invest in new technology that is already financially viable because it reduces energy costs, should it now be paid by taxpayers to do it as it also will reduce emissions? What about market fluctuations or overall industry trends like falling demand for power leading to reduced emissions? Or if a farmer is required to plant trees or reduce land clearing by state laws should these activities be regarded as additional?

Some emission reduction schemes have sought to test whether individual projects would be financially viable without additional financial support – called "financial additionality".

But the Carbon Farming Initiative for the land sector – introduced by the former government – uses a baseline and credit scheme crediting activities that go "beyond common practice". Similarly, the Green Paper proposes to credit "new" projects and determine additionality relative to "past practices".

However, this approach is not without its difficulties. As is clear, such schemes are extremely complex and careful drafting of legislation and methodologies is required. If care is not taken there can be real uncertainty about which projects are covered. This was illustrated by a recent challenge to one of the CFI methodologies in the Administrative Appeals Tribunal.

In the AAT case, a piggery operator, Jock Charles, challenged the methodology introduced under the Carbon Credits (Carbon Farming Initiative) Act 2011 ("CCCFI") for destruction of methane from piggeries using biodigesters. The methodology included a requirement that for projects to earn Australian Carbon Credit Units the biodigesters had to have been replaced or installed after 1 July 2010. This excluded Charles, who was one of the first in Australia to install anaerobic digestion at his piggery to capture methane and generate heat and electricity.

In the case, the government argued that the "fundamental premise" of the CFI was that abatement was to be measured relative to the status quo at the time of the scheme's introduction. Charles argued that this restriction had the effect of punishing those who adopted innovative technologies at an early stage. The AAT agreed with Charles, finding that the test under the legislation was whether a project went beyond "common practice" not whether it was already operating on 1 July 2010. AAT Deputy President Forgie said:

" ... the broader policy of CCCFI is to increase projects directed to abatement and sequestration by means of an incentive ... To exclude those pathfinders by means of a requirement in the methodology determination that their equipment be installed or replaced by a certain date would run counter to the additionality test which they clearly pass. ...

It is one thing to make a large capital investment in a market in which others have chosen not to make that investment. It is another to make it in market that presents the same constraints and opportunities to that person as before but which, to that person's competitors, presents opportunities ..."

What the Charles case illustrates is that, depending on how legislation is drafted and where policy makers want to draw the line, early movers like Charles that have already taken action to reduce emissions and are still doing so can miss out, while competitors who have not taken similar action and are still comparatively inefficient can be rewarded for not having taken action.

Under the carbon price, those companies that put in place measures to reduce emissions were in the same position whether they did so before or after the introduction of the scheme. However, under a baseline and credit scheme – like that proposed for the ERF – there is a requirement for lines to be drawn against which efforts to reduce emissions can be measured. When such lines are drawn there are inevitably winners and losers.

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