Having recently returned from the United Kingdom in July this year where I was working as a Waste and Renewables lawyer for 7 years, I have been immersed in the recent Australian Federal Government's (Government) policy response to Climate Change, notably Professor Ross Garnaut's (Professor Garnaut) numerous detailed reports1 and the Government's Green Paper on the Carbon Pollution Reduction Scheme (CPRS). I have also recently completed an academic paper for my Masters of Environmental Law at Sydney University on Energy and Climate Law discussing whether the CPRS will require measures that complement it to accommodate market failures (Complementary Measures).
Prior to returning to Australia, I started thinking about my approach to Climate Change in Australia in comparison to the UK and Europe. I have been mindful to keep an open mind in respect of most aspects of Climate Change because, even though I have practiced predominately in this area since early 20012, I realised that Australia has a different climate and economy and that its response may be different from the rest of the world.
So, the first assumption that I challenged was whether the core Complementary Measures for change in the UK and Europe would be relevant to Australia. My experience (as well as academic research)3 showed that emission trading made some impact, however, it was Complementary Measures that predominately drives the greenhouse gas (GHG) abatement. My academic paper also formed the view that Complementary Measures will be required.
This article does not discuss in detail the CPRS, but what 'market failures' may occur to the CPRS. It then discusses the Complementary Measures for financing mitigating technology in the UK and Europe as well as current Australian drivers.
Basis for Complementary Measures
Professor Garnaut is pro market. He believes that Complementary Measures should only be implemented when there is a 'market failure' of the CPRS. He also notes that current known market failures are: innovation, research, development and commercialising of mitigating technologies, information, demand side energy use, network infrastructure and supporting governance arrangements4. Professor Garnaut also notes that Climate Change will have catastrophic impacts on Australia unless determined action is taken to abate our GHG emissions.5
The Government's Green Paper notes that '...other measures will be required to address market failures that a carbon price alone cannot overcome or to deal with the distributional consequences of the scheme'.6 The Federal Government will confirm its interim trajectory in its White Paper due at the end of 2008.
Therefore, it is upon these assumptions that I discuss what core 'market failures' may occur to the CPRS and then propose suggested Complementary Measures to the CPRS to assist in the financing of mitigating technology.
Possible Market Failures to the CPRS
I believe that there are two core market failures to the CPRS, namely: the current economic crisis and recently revised environmental predictions.
Economic Crisis 2008
Firstly, it is widely acknowledged that the 2008 economic crisis is the worst since 1930. Much criticism has been directed towards governments for bailing out ailing financial institutions to protect the majority of are left exposed. This has created a 'moral hazard' by breaking the link between remuneration and risk. I note that the Reserve Bank of Australia Governor, Glenn Stevens has warned that greater regulation likely in financial markets.7 Commentators have stated that it is possibly the 'end of raw capitalism'.8 Noting this 'market failure', it is important that smart regulation is implemented through Complementary Measures.
Pass Through of Carbon Liability
Secondly, I believe that Complementary Measures will be required is because the CPRS will work as it is intended, as a market, if liable parties purchase their Australian Emissions Units (AEUs) for each tonne of GHG emitted and don't invest in abatement technology: especially if they can pass on the cost to the end consumer. What is possibly needed is an agreed change of law mechanism where operating and capital costs are assigned to the most appropriate party and some capital costs are shared, possibly on a sliding scale. This should be coupled with benchmarking or market testing of services over an agreed period of time: say 5 years. A draconian pass through of carbon liability is inadequate to protect counterparties as a more mature view is recognising the commercial nature of transactions and hardship based on contractual provisions is generally not ideal. This would provide parties with certainty and fairness in dealing with the CPRS and any other changes in law. Once again, this concept has been adopted in renewable energy project finance deals generally over 5-7 years in duration.
Cost of Inter-Bank Lending
Thirdly, liable parties may purchase AEUs rather than invest in abatement technology is the cost of inter-bank lending. These rates have increased substantially recently, and for Australian banks, lending rates have decreased slightly from a high of 7.25% from April to August 2008 reducing slightly to 7.02% in September 2008: however it is still the highest range since July 1998 where the average has been around 5%9. The London Interbank Offer Rate (LIBOR) which is the inter-bank lending rate in London, has fluctuated from a low on 5 September 2008 of 5.97% to a high of 6.50% on 1 October 2008 for 12 month loans.10
In plain English, this means that debt funding of abatement projects will be more expensive than it was in past years coupled with tighter regulation for providing debt which is likely to see liable parties purchase AEUs rather than abate their GHG emissions.
Revised Environmental Predictions
Secondly, recent environmental research by leading climate scientist, James Hansen, suggests that the 'earth's climate system was about twice as sensitive to carbon dioxide pollution as the Intergovernmental Panel on Climate Change (IPCC) had found. This implies there is already enough greenhouse gas pollution in the atmosphere to cause 2 degrees of warming, bringing about conditions not seen on earth for 2-3 million years and constituting...a degree of warming that would surly yield dangerous climate impacts'11. Hansen suggests that carbon dioxide will need to be reduced from its current 385ppm to at most 350ppm which he states can only be achieved by phasing out all conventional coal burning by 2030 and by aggressively reduction the amount of carbon dioxide in the atmosphere by capturing.....
A Study published on 3 April 2008 by Roger Pielke, Tom Wigley and Christopher Green12 examined the IPCC projections that guide current thinking on GHG emission reductions. They found that, as the IPCC projections included assumptions that 'built in' emission reductions would occur, the real task if four times larger than the IPCC projections indicated...and would mean the implementation of clean technologies about 10 times faster than is projected by the most ambitious of the IPCC scenarios.
Therefore, having established my core 'market failures' that may occur through the implementation of the CPRS, I now will discuss the possible Complementary Measures that could be implemented with an eye to Europe/UK.
The UK Position
So, what Complementary Measures are currently being adopted in the United Kingdom?
The United Kingdom implemented an Emissions Trading Scheme (UK ETS)13 in 2002 in order to prepare for the implementation of the European Union Emissions Trading Scheme (EU ETS) in 200514. The EU ETS has now entered its first mandatory operating phase (First Commitment Period). However, the UK and EU ETS have not been the main drivers of technical advancement in mitigating technology and have not been the main source of funding for abatement technology projects.
The main drivers and sources of funding for abatement technology projects in the United Kingdom have been as follows:
- PFI credits (if the Project is a PFI Project) will be a source of upfront funding from the Government15 for part of the capex cost where debt and equity investment is traditionally split 80:20;
- Credit Guarantee Finance (CGF)16 where the relevant Project procures funding from a public sector body (mainly HM Treasury) at market rates as an alternative to PPP/PFI. This could be an interesting for Infrastructure Australia to consider in the current financial market;
- Prudential Borrowing, where the government funds part of the project as it can borrow money more cheaply than the private sector;
- Renewable Obligation Certificates (ROCs) provide a financial benefit to a renewable generator under the Renewable's Obligation. The ROC is a financial derivative which is granted to an eligible renewable generator (i.e. wind/solar/wave/tidal/CHP) and is currently valued in the market place at £48 per megawatt hour. Fossil fuel generators are not eligible for this financial incentive. Banks will look to the ROC as part of its funding package17. Following consultation, the ROC will be structured more aggressively by allocating ROCs to different technology bands (i.e. Emerging Technologies to receive 2 ROCs, Post Demonstration Technologies 1.5 ROCs, Demonstration Technologies 1 ROC and Established Technologies 0.25 ROCs). This banding will come into force in April 2009;
- The Climate Change Levy18 which is a tax on electricity generation from fossil fuels. The tax is broken down into different values per feed stock (i.e. oil/gas etc). The principal concept is that renewable generators are exempt from this tax and granted a Levy Exemption Certificate (LEC) which is a tradeable commodity and therefore incentivised to develop renewable technologies19. Banks will look to the LEC as part of its funding package and is often linked to the ROC.
The UK have also introduced a series of new climate change policies, namely:
- The Shadow Cost of Carbon (SPC) which
is used to value the expected increase or decrease in GHG emissions
resulting from a proposed policy. In short, the SPC is a separate
cost of carbon from the market cost. It is based on the Social
Costs of Carbon (SCC) for a given trajectory but
can be adjusted to reflect estimates of the material abatement
costs required to take the world into the stabilisation goal and
other factors that may affect UK willingness to pay for reductions
in carbon emissions such as political desire to show leadership in
tackling climate change20.
The UK has adopted a SPC based on the SCC at the top of the 450-550ppm GHG emission range suggested by Sir Nicholas Stern. Interestingly, unlike a large part of the debate in Australia, the UK have assumed that other countries will move to achieve this goal even though it is only responsible for 2% of global emissions with Australia responsible for 2.1%21. The UK Government has adopted a SPC of £26.50 t/GHG for 2008 and this is currently being implemented in contracts across the UK, notably the Merseyside Waste Disposal Authority's Waste Project, where Carl Beer, the Director of the Project, noted that the SPC had made up 2.8% of the total evaluation criteria.
- The Carbon Reduction Commitment (CRC)
introduced as part of the UK Energy Efficiency Plan 2007
(Plan). The CRC is a cap and trade scheme
for the non-household sector not captured under the EU ETS.
Australia implemented the Energy Efficiency Opportunities
Act 2006 (Cth) (EEO Act) which aims
to implement assessment and reporting standards and improve energy
efficiency through its Energy Measurement Guide: it does not
regulate or directly incentivise energy efficiency. It is
anticipated that the National Greenhouse and Energy Reporting
Act 2007 (Cth) (NGER Act) will
supersede the EEO Act and will probably capture some large
corporate groups under the consumption/production/emission
thresholds some of which decline in the first three years. Garnaut
has persistently called for a mandatory energy efficiency mechanism
so maybe, as with the emissions trading scheme they will look to
Europe for answers.
The Plan also sets out other policies, such as:
- An Energy Efficiency Saving of 9% by 2016;
- Delivering zero carbon homes by 2016;
- Energy Performance Certificates for all homes sold and/or rented;
- Grants for micro generation technologies;
- Tax allowances of 100% available for business that purchase energy saving plant/machinery in the year of purchase;
- Interest free loans to medium sized enterprises; and
- Reduced VAT rate for energy savings materials.
The Australian Position
So, having reviewed the core UK Complementary Measures what is the Australian position?
At a Federal level, Australia is aiming to implement the CPRS in 2010 and implemented the National Greenhouse & Energy Reporting Act 2007 (Cth) (NGER Act) which establishes a single national framework for reporting greenhouse gas emissions, abatement actions and energy consumption and production by corporations from July 1 2008 with information made publicly available. Failure to register may result in a civil penalty up to $220,000.00. Companies not captured may voluntarily elect to report their GHG emissions.
The thresholds under the NGER Act are:
- 'control facilities' emit equal to or more than 25,000.00 t/GHGs per annum or produce 100 Terajoules of energy or more or consumes 100 Terajoules of energy or more per annum;
- 'corporate group' emits 125,000.00 t/GHGs per annum or produces 500 Terajoules of energy or more per annum or consumes 500 Terajoules or more of energy per annum22;
At a recent presentation by Professor Garnaut at the Paddington Town Hall in Sydney on 10 July 2008, I asked Professor Garnaut, that in order to facilitate development of mitigating technology, Complementary Measures similar to the UK would be ideal and was he looking to implement similar concepts. His response was that the intention of the CPRS is to provide all the necessary incentive for technology providers to design, demonstrate, build, fund and operate new technologies. This in part is hoped to be achieved by a high Australian Emission Unit (AEU) price in future years23 as well as a reinvestment of proceeds of the 'auction' of AEUs to assist with technological advancement as a form of 'feed-in' tariff.
The UK is acknowledged as a world leader in Renewable Energy: even so, it has not been able to rely on the UK/EU ETS to fund change. This has been in part due to the novelty of the trading but also the variation in the carbon price. The EU ETS carbon price oscillated sharply from €29.20 (April 06) to just €0.11 cents (July 07). The UK Government has sought to stimulate technological development, in part, through the ROC and the LEC as well as other Complementary Measures. Indeed, change has been slower than anticipated, which has resulted in the restructuring of the ROC.
The Complementary Measures for technological change are of immediate importance. If the UK has been unable to rely solely on the UK/EU ETS for technological development how will the CPRS realistically incentivise technological development In addition, the CPRS places a enormous responsibility on the government to fund the correct technology that will deliver the required change rather than relying on the expertise of the private sector. Professor Warnick McKibbin24 commented that he does not believe the CPRS will effectively fund new technologies without Complementary Measures.
The proposed certificate (i.e. REC) under the Federal Government's proposed Renewable Energy Target is a start, but 'banding' of the REC and the additional levy on fossil fuel generation (i.e. LEC) as well as other Complementary Measures will probably be required sooner rather than later.
Having identified what I perceive to be market failures under the CPRS, I have hopefully identified what Complementary Measures the UK have adopted which may assist the reader to consider alternative practical approaches to correct possible future 'market failures'.
There is strong support amongst consultees to the CPRS for additional Complementary Measures similar to the UK. Some examples have included:
- the Landfill Allowance Trading Scheme (LATs) where a declining cap is placed on the amount of Biodegradable Waste that can be sent to landfill by Local Authorities enforced by a penalty of £150 pounds per tonne, which I have direct experience of transacting LATs Agreements as well as the Waste PFI/PPP Contracts that it encourages;
- a Renewable Energy Certificate for heat produced from a renewable source; and
- a remanufacturing incentive (i.e. incentivising the use of recycled materials in manufacturing) through a National Landfill Target (which could be structured as a baseline and credit scheme similar to LATs), a Secondary Market incentive to purchase manufactured product with a percentage of recycled material (which could be structured on similar lines to the REC and/or LEC);
Australian Venture Capitalists and Banks are not looking to include these Complementary Measures as part of their funding and security package: unlike the UK/EU. This should change when the market becomes more mature. What is needed is for companies to understand these Complementary Measures and how they impact of their current/future funding and project risks. For example, do their current contracts deal with changes in law properly or do they apportion risk for changes in legislation in the draconian pass through method.
Time will tell whether the CPRS will have sufficient clout and buy-in to enable the carbon price to incentivise operators to develop abatement technologies. It is imperative that the technological drive for change is a mechanism that is robust and will incentivise new technological providers from Australia and abroad to develop and implement changes that could bring solutions to what is a most immediate and present danger.
- For a complete list of Professor Ross Garnaut's reports see www.garnautreview.org.au accessed 4 November 2008.
- Dermot worked for leading London firms from April 2001 to June 2008: Nabarro (Cogeneration/Electricity/Wind/PPP/PFI); PinsentMasons (Wind/Infrastructure/PPP/PFI) and Bevan Brittan LLP (Waste/Wind/Energy Efficiency/PPP/PFI).
- HM Government, Climate Change: UK Action Programme 2006: Tomorrows Challenge (2006) at 124.
- Professor Ross Garnaut, Garnaut Climate Change Review: Interim Report to the Commonwealth, State and Territory Governments of Australia at 45.
- Garnaut, above n 4 at 23 where he tables likely impacts of climate change in Australia per increase in degree.
- Commonwealth Government Department of Climate Change, Carbon Pollution Reduction Scheme Green Paper: Summary Report: July 2008 (Green Paper).
- Adrian Rollins, 'RBA chief mulls earlier financial intervention' Australian Financial Review (18 September 2008) at 3.
- Tony Walker, Perspective, 'The end of raw capitalism', Australian Financial Review (20-21 September 2008) at 18-20.
- Reserve Bank of Australia at Interbank Cash Market Rate http://www.rba.gov.au/Statistics/AlphaListing/alpha_listing_i.html accessed on 5 November 2008.
- British Banking Association: 2008 Historical LIBOR rates at http://www.bba.org.uk/content/1/c6/01/46/27/Oct08.xls accessed on 5 November 2008.
- Tim Flannery, 'The Essay: The coal conundrum' Sydney Morning Herald Weekend Edition (20-21 September 2008) at 30.
- The UK ETS came into force in 2002 on a trial basis to enable the UK to understand emission trading prior to the commencement of the EU ETS and has now been incorporated into the EU ETS.
- The EU ETS began operating in 2005 on a trial basis until the first commitment period of 2008-2012.
- The core difference between a PPP Project and PFI Project is that the UK Government grants PFI Credits (i.e. a funding injection for the capital cost) and a PPP Project is not eligible for this financial assistance.
- Credit Guarantee Finance was introduced by HM Treasury as an alternative method of financing to PPP/PFI projects in 2004.
- The Australian Federal Government recently consulted on a similar mechanism under the proposed Renewable Energy Target (RET) (which is to replace the Mandatory Renewable Energy Target (MRET).
- The Climate Change Levy was introduced in April 2001 under the Finance Act 2000 (UK) and consolidated by the Climate Change Levy (General) Regulations 2001 (UK).
- The Australian Federal Government has not released any information to my knowledge on a similar mechanism for Australia.
- The SCC is often referred to as the loss of the Great Barrier Reef, Ningaloo Reef and the Kakadu Wetlands which the CPRS does not protect and is perceived by Professor Ross Garnaut as a possible 'market failure' of the CPRS.
- The UK position moves forward from the 'prisoner dilemma' (i.e. not implementing the CPRS until we have international agreement) afflicting Australia at present on Climate Change. It is interesting to note that the 'prisoner dilemma' is what is widely viewed as the stumbling block of the Free Trade Agreement which collapsed in July 2008.
- The Corporate Group threshold listed in s 13(1)(a)-(c) of the NGER Act decrease for the first three years of the operation of the NGER Act which will capture more corporations.
- Interestingly, with the higher cost of debt due to the financial crises and high inter bank lending rates the value of futures on the AEU for financial year 2011/2012 has risen dramatically to A$21.75 in October 2008 see http:///www.pointcarbon.com/news/1.976838.
- Board Member of the Reserve Bank of Australia: interview on Lateline on Friday 11 July 2008.
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