Australia: The debate over a carbon tax is over but the time for action has come

For the immediate term, the debate in the business community about the relative merits of a carbon tax and Direct Action is over. This year, the question confronting companies is – are you in or are you out?

Until now, with uncertainty as to whether the Emission Reduction Fund would ever come into operation, companies may have not done the calculations on whether to bid for government contracts to reduce their emissions.

The ERF legislation finally passed through both houses of Federal Parliament late last year and companies must now decide whether it is worth the expense and the effort to bid for contracts totalling $2.55 billion.

For those wishing to get a first mover advantage, time is relatively short. The Environment Minister has indicated that the first ERF auction will be held in the first quarter of this year.

Before that can occur though a number of things need to happen. The Clean Energy Regulator has now released the draft rules for the auction process and the final version of the standard carbon abatement contract that companies will bid for.

Emissions reduction methods (methods), setting out the rules for determining emissions reductions from different activities and sectors, are also in the process of being finalised.

What will be keenly anticipated is whether the Regulator releases a "benchmark" price for bids ahead of the first auction.

To help companies understand the ERF, we have prepared a summary of the scheme and the process.

The ERF has three elements:

  • crediting emissions
  • purchasing emissions, and
  • safeguarding emission reductions.

Crediting emissions

The Clean Energy Regulator (Regulator) will issue Australian carbon credit units (ACCUs) for emissions reductions that are created and audited under approved methods. These credits can then be purchased by the Government through the Emissions Reduction Fund, used under voluntary carbon offsetting programs or sold to other companies.

At the commencement of the ERF there will be around 30 methods, including those approved for the existing Carbon Farming Initiative. The new specific methods initially prioritised for the ERF cover the waste, transport, energy efficiency and coal mine sectors. Priority will be given to the development of further methods that deliver volume and speed to market of projects.

There are two types of methods:

  • activity methods for specific emissions reduction actions, and
  • facility methods that can aggregate emissions reductions from multiple activities at facilities for which data is reported at the facility level under the National Greenhouse and Energy Reporting Scheme (NGERS).

These methods and the ERF legislation will determine the eligibility of a project, including whether it is delivering real and additional emissions reductions over and above business-as-usual activity.

Activity method example - Carbon Credits (Carbon Farming Initiative) Methodology (Commercial Buildings) Determination 2014 (consultation draft)
This draft method for generating credits from improving the energy efficiency of commercial buildings requires that each building in the project must have, or be eligible to have, a NABERS energy rating as a commercial building. The project must not involve activities that limit the use of the building, or reduce service levels provided in the building, for the purpose of reducing electricity or fuel consumption. Baseline emissions are calculated with reference to a baseline NABERS energy rating. A minimum amount of abatement is required under the method - a one-star improvement in the NABERS energy rating for a building, compared to the baseline NABERS energy rating for the building.
Carbon Credits (Carbon Farming Initiative) Methodology (Facilities) Determination 2014 (consultation draft)
This draft method aggregates emissions reductions from multiple activities at facilities, other than transport facilities, for which data is reported at the facility level under NGERS. The method provides that:
  • the baseline period for the project is the prior four NGERS reporting years (unless a major change, see below, has occurred in the earliest two years of that period or reporting has not occurred for all of those years)
  • the facility must not have undergone a major change in the prior two NGERS reporting years (such change being a ramp up, plant shutdown, major maintenance activity, significant expansion or significant production variable change)
  • one or more production variables (being a saleable product from a chemical or physical process where a change in quantity of the product produced results in a change to the emissions from the facility) are to be nominated
  • the baseline emissions intensity for each production variable will be set at the lowest emission intensity ratio during the baseline period, and
  • emissions reductions are improvements in the emissions intensity for the production variable over the emissions intensity for the baseline period.

ACCUs can only be credited for an eligible offsets project, which requires basic identity and probity checks of the proponent to be undertaken as part of a fit and proper person test. For eligibility, proponents will also need to show their project has not begun to be implemented before it has been registered with the Regulator.

The duration of the crediting period for a project will be seven years except for sequestration or savanna burning projects, which have a 25 year crediting period, or where the method provides otherwise.

Purchasing emissions

Four auctions will be held in the first year, with an initial minimum bid size of 2,000 tonnes of CO2-e per year.

Participants will submit a bid specifying a price per tonne of projected emissions reductions to the Regulator with the lowest-cost projects being selected. Participants will not be able to see what other companies are bidding.

The Government will only purchase 80 per cent of emission reductions offered for sale below the maximum "benchmark" price the Government is willing to pay. The Regulator will determine this benchmark price in advance of each auction. For the first auction, the Regulator will have the discretion to release the benchmark price ahead of bidding to encourage early participation. The weighted average price paid across successful bids will be published by the Regulator after each auction.

Projects must be registered before a bid can be submitted. To register a project, participants will need to confirm their identity and probity and propose a schedule of annual emissions reductions estimated in accordance with an approved method. A company's previous record of delivering contracted emission reductions – or more particularly failure to deliver – will be considered, along with commercial readiness of the technology or practice and the capacity of the project proponent to carry out the project.

Participants will only be able to submit one bid for each project and once a project is successful at auction it cannot be re-bid into a later auction.

Once a bidder is successful it will enter into a standard form contract with the Government. Details provided by the bidder before the auction – quantity of ACCUs to be delivered, price and delivery schedule – will automatically become terms of the contract. However, the substantive obligations of the contract – to deliver and purchase ACCUs – will only come into effect once certain conditions precedents have been met. These conditions precedents will include demonstrating evidence of the seller's capacity and authority to enter into the contract and availability of sufficient funds to operate the project.

The core obligation of the seller under the contract is to deliver to the Government ACCUs at the scheduled time, with payment on delivery. The contract provides for liquidated damages to be payable in the event of termination or failure to deliver the agreed ACCUs. Some flexibility in relation to the timing of delivery of the ACCUs is provided for in the contract, which may relieve the seller from liquidated damages for late delivery.

In response to concerns that the five-year contracts initially proposed to be offered under the ERF were too short, the Government has agreed to amendments to the ERF legislation providing that the Regulator must have regard to rules made by the Environment Minister. The rules must have regard to the principle that the duration of a contract should not be longer than seven years except for sequestration and savanna burning, where a longer period may be appropriate. However, as the Regulator and the Minister are only required to "have regard" to these time periods, the contract durations could be shorter or longer than seven years.

Safeguarding emissions

The final part of the ERF scheme is the Safeguard Mechanism. It will apply to large emitters that exceed their historical absolute emissions levels - otherwise known as baselines. Companies that exceed their baseline will be required to surrender to the government "prescribed carbon credit units" to offset excess emissions.

The objective of the safeguard mechanism is to ensure that emissions reductions purchased through the ERF are not negated by a significant rise in emissions elsewhere in the economy.

It will apply to around 130 companies with facilities that emit over 100,000 tonnes of CO2-e per year, accounting for around 52 per cent of Australia's emissions. Notably, it is intended that company baselines will be set at the level corresponding to the year of highest emissions over the last five-year period.

However, the mechanism will not commence until 1 July, 2016. Before then, under amendments agreed to by the Government in the Senate the Environment Minister must "take all reasonable steps" to ensure that regulations setting the baselines and related penalties are in force from 1 July 2016. In setting penalties the Minister must have regard to "the principle that a responsible emitter must not be allowed to benefit from non-compliance, having regard to the financial advantage the responsible emitter could be reasonably expected to derive from an excess emissions situation". An "excess emissions situation" is where a baseline is exceeded.

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.

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Marcus Priest
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