Green Paper – Emissions Reduction Fund
The Australian Federal Government (Government) released a Green Paper on Friday 20 December as part of its Direct Action Plan on climate change policy. The Green Paper outlines the Government's preferred design for an Emissions Reduction Fund (Fund) and invites further input from business and the community on the design elements outlined in the Green Paper by 21 February 2014, before a White Paper is released in 'early' 2014.
This Legal Insight summarises the Government's preferred design and readers should assume that the Government is seeking input on all aspects of the design.
Recognition of Climate Change
The Green Paper contains a clear acknowledgement by the Government that human activities have resulted in climate change. The Government restates its commitment to reduce Australia's greenhouse gas emissions by 5% on 2000 levels by 2020. This commitment is subject to review in 2015 to take account of action by major economies and trading partners in progressing to a new global agreement on emissions reductions.
The Green Paper states that there are two principal models for achieving reduced emissions:
- An emissions trading scheme where the total emissions are capped and liable entities can trade emissions entitlements (including emissions reductions credits acquired from entities who have reduced their emissions) up to the cap. Examples of cap and trade schemes are the current Australian Emissions Trading Scheme post 2015, the European Union Emissions Trading System (EU ETS), the Californian Cap and Trade Program, and the Quebec Cap and Trade System.
- The Government purchasing emissions reductions from entities with verifiable reduction activities.
The Green Paper states that it is the Government's preference to proceed with model 2 and to establish the Fund to purchase emissions reductions. The Government considers that the issue of credits under the United Nation's Clean Development Mechanism (CDM) is "arguably the most effective system in the world". However, the credits issued under the CDM are not purchased with money from a global fund, they are purchased by entities with liabilities under an emissions trading scheme such as the EU ETS. In other words, the CDM only operates because of the existence of an associated ETS.
The Green Paper acknowledges that in addition to the Fund, a 'Safeguard Mechanism' is also required to (a) safeguard the value of the Fund, and (b) provide an incentive to stop emitters from increasing their emissions above their historical baselines. This Safeguard Mechanism is described at the end of this article.
Principal Design Features Of the Fund
The Green Paper states that the Fund will be the primary means by which the Government achieves its commitment to reduce Australia's emissions by 5% on 2000 emissions by 2020. This requires a reduction of 431mtCO2-e in aggregate over the six year period (or 71.8mtCO2-e pa). In our view, and as outlined below, the Safeguard Mechanism is equally necessary to guarantee that reduction.
The principal design features are as follows:
- Duration – the Fund is anticipated to commence (subject to legislation being passed) on 1 July 2014 and continue until 2020.
- Funding – initial allocated funding comprises AUD300m year one, AUD500m year two and AUD750m year three. No commitment has as yet been budgeted for years four to six.
- Governance – the Fund will be operated by the Clean Energy Regulator.
- Overarching principles:
- the Fund will purchase the lowest cost emissions reductions
- the emissions reductions must be verifiable and from projects located within Australia (although the Government is seeking input on the possibility of allowing international emissions reductions to participate)
- simple administration.
- Verification/eligibility – entities wishing to offer emissions reductions for purchase by the Fund will need to have an emissions reduction methodology for the project approved by the Clean Energy Regulator. The approval process will be a streamlined version of the process under the Carbon Farming Initiative (CFI).
- Additionality – to be eligible for participation in the Fund, emissions reduction projects must:
- create reductions which are additional to normal business practice and any mandated requirements under state based legislation
- not be from activities which have received credits under another scheme.
For example, projects earning energy savings certificates under the New South Wales (NSW) or Victorian (VIC) schemes will not be eligible for participation in the Fund (unless they surrender those certificates) whereas projects identified in the Energy Efficiency Opportunities Program will be eligible for participation in the Fund. This is because the Energy Efficiency Opportunities Program is a voluntary program which does not 'reward' or pay 'compensation' for emissions reductions.
- Coverage – all existing and future methodologies approved under the CFI will be treated as being eligible for participation in the Fund. The Government is seeking feedback on which additional methodologies should be fast tracked under the approval process, including:
- cleaning up waste coal mine gas
- cleaning up power stations
- improving energy efficiency in commercial buildings
- replanting marginal lands
- improving soil productivity.
Methodologies for some of these activities have already been developed under the NSW Greenhouse Gas Reduction Scheme, state based energy savings schemes, the CDM and the Alberta-based Offsets Credit Scheme. The Government proposes using existing methodologies under such schemes and adapting these to suit Australian conditions where necessary.
- Entitlements offered for sale – entities can offer to sell to the Fund (1) existing Australian Carbon Credit Units (ACCUs) issued under the CFI, or (2) future ACCUs created from approved emissions reduction projects. If the Clean Energy Regulator accepts an offer for future ACCUs, it will enter into a standard contract with the seller under which stage payments can be made over a maximum five year period for delivery of ACCUs over that period. If payments are made in advance of delivery, a 'make good' mechanism will be included for under delivery.
- Sale process – initially the Clean Energy Regulator will run a tender process calling for sealed bids offering ACCUs or forward contracts for ACCUs for purchase by the Fund. Over the longer term, a reverse auction will be established.
- Purchase price – the Government will set a maximum purchase price for the purchase of ACCUs or forward contracts for ACCUs. The maximum purchase price will be confidential. However, the aggregated price paid by the Clean Energy Regulator at each tender/auction will be published so entities will be able to determine the maximum price quite readily after the tender/auction.
- Review process – the Government has flagged a review of the Fund at the end of 2015.
Problematic Issues In the Design Of the Fund
- Five year payback period – early commentary on the Fund design raises concerns over the feasibility of businesses being able to establish projects with a five year payback period. This seems a likely requirement for any external financing given the Fund design principles. The Green Paper states that the Energy Efficiency Opportunities Program reports, prepared by large energy users, indicate that those entities have identified projects which could result in 50mtCO2-e annual emissions reductions by 2020 from projects with payback periods ranging from "less than two to more than four years". However, it is not known how much of that reduction is from projects with a five year or shorter payback period.
- Sufficiency of purchase price – extrapolations from the required target and available funding suggest a purchase price per tCO2-e reduction of between AUD7 and AUD15. Whether this is sufficient to fund projects with a five year payback period is uncertain.
The Government acknowledges that in addition to purchasing emissions, it will need to introduce a Safeguard Mechanism to provide an incentive to emitters so that they do not exceed their historical baselines. The design features of the Safeguard Mechanism are as follows.
- Mechanism start date – 1 July 2015.
- Liable entities – facilities reporting under the National Greenhouse Energy Reporting Act (NGER Act).
- Historical baselines – based on NGER Act data.
- Growth – the baselines can be increased to account for additional growth at best practice emissions limitations.
- New entrants – the Safeguard Mechanism will allow best practice baselines to be established for new entrants.
- Compliance – the Safeguard Mechanism will provide an 'incentive' to liable entities to remain within baselines (possibly over several years). The incentive is not intended to be revenue generating nor punitive and may allow liable entities to purchase ACCUs or international emissions units to 'counter-balance' the excess of their emissions above their baselines.
Problematic Issues In the Design of the Safeguard Mechanism
In order to provide an incentive for compliance and to support the commitment to reduce emissions by 5%, some form of sanction will be required. Without a sanction, there is no guarantee that the emissions reduction target can be achieved. This is because buying reductions from participants under the Fund will only achieve overall reductions in Australia if the emissions from non-Fund participants do not increase in the same period.
For example, if Power Station A sells 50 mtC02-e to the Fund for the five year period and Power Station B increases its emissions over the same period by 50mtCO2-e the net emissions reduction outcome is zero. If the price of emissions reductions paid by the Fund does not exceed the profits earned by Power Station B, Power Station B will have no interest in participating in the Fund nor limiting its emissions. If there is no sanction restricting Power Station B from increasing its emissions, it may well do so if this increases its profitability.
The Government has said the Safeguard Mechanism is not intended to be revenue generating nor punitive. But without some form of sanction the target will not be reached and the value of ACCUs (and contracts for ACCUs) will be nominal.
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.