Our previous articles of 11 March 2009 and 13 March 2009 outline two of the central planks in the Federal Governments Carbon Pollution Reduction Scheme Bill 2009, namely:
- who is liable for emissions under the Bill?; and
- what is the nature of the instrument to discharge that liability (the Australian emissions unit)?
To continue our series on analysing the draft Bill in detail, below we examine the mechanism by which emitters will discharge their liability for emissions.
Obligation to surrender units
In summary, the Bill imposes an obligation on liable entities to surrender Australian emission units equal to that entity's emissions number for an eligible financial year, in order to avoid a unit shortfall (Clause 132).
The statement above identifies a number of key concepts in Part 6 of the Bill which we summarise below.
Key Concept 1 – Liable entities
Our article of 11 March 2009 set out the mechanism for determining when an entity would be liable for emissions. A copy of that article is available at our website www.hopgoodganim.com.au. In summary, the Bill imposes primary liability on emitters controlling a facility which emits more than 25,000 carbon dioxide equivalance of greenhouse gases in an eligible financial year. Manufacturers and suppliers of certain fuels are separately caught as liable entities under the Bill.
Key Concept 2 – Emissions number
Clause 125 of the Bill sets out the formula for determining how many Australian emissions units are required to be surrendered in an eligible financial year in discharge of emissions liability. In essence, the formula applies as follows:
- determine the number of emissions for which emitters are provisionally liable in a financial year (eg, by directly emitting those emissions or manufacturing the fuel that gives rise to potential emissions – see our article of 11 March 2009 at our website, www.hopgoodganim.com.au);
- plus any make good emissions (discussed below); and
- less the number of excess surrender units (where an entity over-surrenders units in a previous financial year).
This formula gives the emissions number; being the number of emissions for which units are required to be surrendered for a financial year.
The Bill makes it clear that the determination of the number of emissions for an entity will be based on the entity's reporting under the National Greenhouse and Energy Reporting Act 2007 (provisions exist for independent assessment where incorrect or no reporting has been made under that Act).
Key Concept 3 - What is the make good number?
Clause 142 of the Bill seeks to ensure that entities remain liable in future years for any shortfalls in the number of emission units surrendered compared to an entity's emission number.
Quite simply, if a unit shortfall exists at 15 December after the end of the financial year, then that shortfall will be deemed to be the make good number for the next financial year. This is achieved under Clause 125(2)(b) of the Bill, which provides that the make good number is added to the deemed emissions of the liable entity for financial year in question.
It is important to note that the concept of making good in future years for shortfalls of surrendered units in previous years applies in addition to the penalty provisions under the Bill. That is, it appears that liable entities will have to both pay a penalty and make good their emissions. Penalties are discussed in further detail below.
Key Concept 4 - What is a unit shortfall?
The concept of a unit shortfall is, as its name suggests, reasonably self explanatory.
If a person fails to surrender sufficient units by 15 December after a financial year equal to that person's emissions number (determined under Clause 125), then that person will have a unit shortfall for the deficiency (Clause 130).
Entities are able to reduce (or eliminate) their unit shortfall for a financial year by borrowing emission units from the next vintage year. However, to ensure that the Bill's objective to see an overall reduction in emissions in line with the national emissions scheme cap is met, a maximum 5% of that entity's emissions number can be borrowed from the next vintage year's emissions units.
To illustrate this concept, consider the following examples:
- Case 1 – The entity has an emissions number of 100,000 for 2010 and surrenders 100,000 emissions units with a 2010 vintage. No unit shortfall or excess surrender arises.
- Case 2 - The entity has an emissions number of 100,000 for 2010 and surrenders 95,000 emissions units with a 2010 vintage. A 5,000 unit shortfall will arise. The entity however 'borrows' 5,000 units with a 2011 vintage to discharge its 2010 liability (note, this is the maximum able to be borrowed, being 5% of the emissions number). No unit shortfall or excess surrender arises.
Key Concept 5 - What is an excess surrender?
The concept of excess surrender arises were an entity has, by 15 December after a financial year, surrendered more emissions units than their emissions number for that year.
As indicated above, this excess surrender number has the effect of reducing the entity's liability for emissions (that is, their emissions number) for the next following year.
However, as with the concept of unit shortfall, Clause 143(2) of the Bill provides that, in determining the excess surrender number, entities can only surrender emissions units from the next vintage year of emissions units, up to a maximum of 5% of that entity's emissions number for that current financial year. This concept is explained in further detail below.
Key Concept 6 – Borrowing explained
As identified in our earlier articles, the structure of the Bill is centred around the Government setting a national scheme cap for each eligible financial year, equal to the maximum number of emissions that the Federal Government will allow from liable entities in that financial year. For that purpose, emissions units are issued with a vintage year which matches emissions units with emissions in a particular year.
It is arguably inconsistent with this concept to allow entities to borrow units having earlier or later vintage years to discharge a current year emissions number liability.
However, in general terms, entities can borrow up to 5% of their emissions from the next year's vintage of units to discharge a current year liability.
Borrowing complications – excess surrender
Clause 143(2) (borrowing units to determine the excess surrender number) when read with its partner provision dealing with unit shortfalls (Clause 130), gives effect to the concept that entities may only borrow a maximum of 5% of the next following vintage year's emissions units for discharging liability for current year emissions.
However, either by design or oversight it appears that Clause 143(2) as presently drafted would unduly penalise an entity who surrenders more than their liability for emissions, including by borrowing from the next following year's vintage of emissions units. That is, if over 5% of that year's emissions number are discharged with borrowed units, the entity will lose the benefit of those units for the vintage year to which they relate, even though the entity has oversurrendered in the current year.
To illustrate this concept, consider the following examples:
- Case 1 - The entity has an emissions number of 90,000 for 2010 and surrenders 100,000 emissions units with a 2010 vintage. Notionally, a 10,000 excess surrender will be able to be carried forward to 2011.
- Case 2 - The entity has an emissions number of 90,000 for 2010 and surrenders 70,000 emissions units with a 2010 vintage. The entity then borrows a further 30,000 units with a 2011 vintage to discharge its 2010 liability. Notionally, a 10,000 excess surrender will be able to be carried forward to 2011 (the year to which a number of the surrendered units relates). However, as more than 5% of the emissions number has been borrowed, no excess surrender will arise. The benefit of the 10,000 units will be lost.
This element highlights the need to ensure that liable entities are extremely careful and vigilant in their system of matching emissions to units held, to ensure the benefits of those units (which have been paid for) are not lost without being able to utilised.
Excess surrender and borrowing units – summary
The policy of the Bill on borrowing units seems to reflect that:
- Earlier vintage years of units can be matched against the immediately subsequent year's emissions (Clause 129(4)(c) – presumably the theory here is that if an entity has decreased its emissions below its expected requirement (and therefore has an excess of units for a particular year), then it should be able to set that excess surrender off against the next year).
- Entities can borrow from a future year's allocations of units (that is, a unit with a future vintage year) but only by borrowing up to 5% of that current year's emissions number.
These concepts seem to allow a smoothing of emissions liability across years, reflecting that actual emissions may not be easily able to be forecast, whilst capping the ability for entities to over borrow in circumstances were they may be unable to repay - by reducing future year's emissions or buying additional units. (The impact of overleveraging (albeit in a different context) in today's economic climate can't be ignored here!).
This paper is the third in our series explaining the key planks in the Federal Government's draft Carbon Pollution Reduction Scheme Bill 2009. It draws together the concepts from our articles of 11 March 2009 (about who is liable for emissions) and 13 March 2009 (about emissions units) in describing the obligation on liable persons to surrender Australian emissions units equal to their emissions number for a financial year.
Whilst there is some scope to borrow between financial years, Clause 133 of the Bill provides that if an entity has a unit shortfall by 15 December after the end of the financial year, then a penalty will be payable equal to an amount prescribed by regulation, or 110% of the average auction price of units for the previous financial year. These penalties may prove costly.
It would appear that in addition, the entity is still required to make good its unit shortfall for that financial year.
These provisions give the Bill real teeth, and provide emitters with real incentives to comply.
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