Australia: Emissions requirement under the National Energy Guarantee: Proposed design up for discussion

There are three key elements to the proposed emissions requirements in the National Energy Guarantee.

The design elements of the emissions requirement under the National Energy Guarantee (NEG) fall into two categories:

  • the setting of the emissions requirement for which the Commonwealth Government is responsible; and
  • the application of the emissions requirement for which the Energy Security Board (ESB) is responsible.

Setting the emissions requirement

The Commonwealth's design elements for the emissions requirement include:

  • setting the emissions reduction target for the National Electricity Market (NEM), including the level and form of the target;
  • the treatment of emissions intensive and trade-exposed activities; and
  • the eligibility of offsets to meet the requirement, and any limits on the use of eligible offsets.

Target

The Government proposes that the emissions reduction target for the NEM is the same as the current national target being 26% below 2005 levels by 2030. The paper states that such a level recognises the competing factors such as providing affordable and reliable electricity supply. However, as it is intended that the NEG have no end date (unlike the Renewable Energy Target), emissions targets beyond 2030 will be required, and these will be considered in the context of five yearly reviews required under the Paris Agreement.

The proposed target will also apply consistently across all jurisdictions in the National Energy Market (NEM), meaning that retailers can meet their obligation from across the NEM, including from jurisdictions that have or propose state-based policies to encourage investment in low-emissions technology.

Form

Not wanting to repeat the experience of the Renewable Energy Target (RET), the Government proposes to set the form of the requirement by reference to criteria that will enable it to self-adjust to changes, such as in demand. The option currently being considered is to express the target as a trajectory of annual average emissions per MWh levels for retailers in the NEM. These would be referred to as "electricity emission targets", with the trajectory being consistent with the 2030 target. The target would therefore remain the same irrespective of whether demand rises or falls during the period.

The initial electricity emission target will be set by reference to forecast future electricity demand in order that the desired level of emissions reduction for the sector can be achieved. The target will also be adjusted to account for exemptions provided for EITE-related activities (see below).

What is unclear is how and when the electricity emission targets will be adjusted to correct for updates to forecasts. The Government is reluctant to introduce uncertainty that would result from changes and proposes that the targets would not be adjusted to account for changes in electricity demand. Rather, any adjustment would occur as part of setting future electricity emission targets, which would occur every five years.

Setting electricity emission targets

The Government proposes to initially set the target trajectory for 10 years from 2021-2030, to align with the commencement of the Paris Agreement. The setting of future targets will also align with the five-yearly review cycle for national targets under that Agreement. Accordingly, targets will be set every five years for a five-year period. This, the Government contends, will ensure that the market has between five and 10 years of targets available to guide investment decisions. To provide further stability, the Government would lock in the target so any change in the trajectory could only apply with a minimum of five years' notice.

Emissions intensive trade exposed activities

The Government's proposal in relation to the treatment of EITE activities is unsurprising. To maintain consistency with the RET, all EITE activities will be exempt from the emissions requirement, with the process for eligibility consistent with the current RET scheme. This means that in order to achieve the desired level of emissions reduction, the electricity emission target will be adjusted upwards to account for the fact that EITE emissions will be exempt.

Offsets

The Government is still considering whether to allow liable retailers to be able to use offsets external to the electricity sector as a flexible compliance option to meet the emissions requirement, and if so, what limits should be placed on that use. Further, while the Government signalled in-principle support for the use of "high-quality" international offsets in the 2017 Climate Change Policy Review, no final decision has been made and it is unlikely to be made while negotiations for the rules of the Paris Agreement are ongoing.

There appears to be an implicit assumption in both the Government and ESB's thinking around the use of offsets that:

  • there will be a liquid market of domestic offsets created under the Carbon Farming Initiative (CFI) available for purchase; and
  • international offsets will remain relatively cheap and freely available after 2020.

No liquid secondary market currently exists for ACCUs generated under the CFI and the absence of commitment to further funding for the Emissions Reduction Fund has already resulted in investment for domestic offset projects drying up. Further, more than 90 countries propose to rely on the use of international credits to meet in part their obligations under the Paris Agreement, and China, the largest exporter of offset credits, has just launched its own emissions trading scheme. In those circumstances, it is hard to see how international credits, whether "high quality" or not, will remain either cheap or in abundant supply by the time the emissions requirement is due to commence.

Application of the emissions requirement

The ESB's design elements for the emissions requirement concern the application of the requirement to the retailer. These include the calculation of the retailer's load, the form of contracting required, compliance options and reporting requirements.

For each year for which electricity emission targets are set, each retailer will be required to meet the target in respect of its own load in that compliance year. A retailer's performance against the target will be determined in tCO2-e per MWh with reference to its load and the emissions associated with tis contracted and uncontracted purchases in the compliance year (subject to any adjustment).

Calculation of load

A retailer's load will be the number of MWh recorded by AEMO as being purchased by that retailer on the wholesale spot market in the relevant compliance year either for its own use or to supply customers. Any electricity that is sold for EITE activities is deducted from the retailer's load.

More difficulty however arises in relation to the calculation of emissions per MWh, as this is influenced by the way in which the retailer contracts to purchase electricity. In general, however, the ESB proposes that:

  • emissions are to be determined by reference to contracts where the emissions per MWh are specified, otherwise it will be necessary to set a basis for determining the level of emissions;
  • deduct any electricity sold to other retailers or other intermediaries;
  • after accounting, determine the emissions associated with the retailer's remaining load by applying a default emissions factor;
  • adjust for any deferral of compliance, under-compliance or over-compliance; and
  • adjust for any voluntary "green" programs, sales to EITE activities or for eligible offsets.

Contracting emissions

Retailers will need to report contracts in order to demonstrate compliance with the emissions requirement. For example, retailers could report contracts which specify the generation source (and therefore enable the emissions per MWh to be directly determined), or contracts which specify the emissions per MWh. Although no contracts in the latter category presently exist in the market, the ESB thinks this could be a possible innovation. More difficulty however exists where contracts specify neither the generation source nor emissions per MWh, such as existing exchange traded and over the counter swaps. In respect of these contracts some form of deemed emissions would need to be assigned.

Compliance

The ESB propose a number of flexible compliance options to minimise costs and to enable management of variables such as generator outages. Included among the proposed flexible options include:

  • retailers being able to carry forward all or a portion of any over-achievement to the next compliance year, similar to the RET;
  • retailers being able to defer a portion of their compliance obligation. To ensure that this does not undermine investment in the NEM or introduce increased market risks, this would be limited to around 20%; and
  • use of offsets (see above), however retailers would be required to use within NEM opportunities before relying on offsets to bring them into compliance.

Reporting and compliance

While the Australian Energy Regulator is the obvious entity to monitor compliance with the emissions requirement, given the complex and numerous contracts that retailers hold, some form of registry is proposed to monitor and verify compliance.

In addition to data sources currently available to marker regulators including dispatch and spot market settlement data, retailers would report information from their contracts into the registry in order to match their load with a power station's dispatch. The registry would track electricity output and match it to the emissions level reported under NGERS. The output of each power station and the emissions associated with it would be attributed to retailers based on reported contracts.

RELATED KNOWLEDGE

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

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