Emissions Reduction Fund White Paper released

In brief

The Federal Government has released its White Paper on the design of the Emissions Reduction Fund. Partner Grant Anderson reports.

Background

The Federal Government has billed its Emissions Reduction Fund (ERF) as the 'central component' or 'centrepiece' of its Direct Action Plan. As such the Government is relying on the ERF to make a substantial contribution to Australia's target of reducing its greenhouse gas emissions to 5 per cent below 2000 levels by 2020. Taking into account updated emissions data for 2013 and 2014, the Government estimates that this will entail a cumulative reduction of around 421MtCO₂-e from 2014 to 2020. While the Government will review this target in 2015 as part of the negotiations on a new global climate change agreement, taking into account the actions of other nations,¹ it has signalled that even this 5 per cent target poses a 'significant challenge' given Australia's increasing emissions. The Government's climate change policy settings, including the ERF, might therefore come under considerable pressure if it has to lift this target as part of any new international agreement.

The recently released White Paper follows on from last year's Green Paper and sets out the Government's decisions as to the design of the ERF, although many of these decisions are fairly predictable because they were largely foreshadowed in the Green Paper. The White Paper does, however, announce the Government's decision to increase committed funds for the ERF from $1.55 billion to $2.55 billion (albeit this is still short of the $3.2 billion that was originally promised)². The next step will be the release of exposure draft legislation to establish the framework for the ERF, which is intended to replace the previous Government's carbon pricing scheme (for more information on this issue see our previous Focus articles of October 2013 and March of this year). However, while the legislation to repeal the carbon pricing scheme looks set to be passed by the new Senate after 1 July 2014, the passage of the legislation relating to the ERF may be more problematic because the majority of the micro-party senators on whose support the Government will need to rely (at least if the Labor opposition and the Australian Greens maintain their opposition to it following the repeal of the carbon pricing scheme) appear currently to oppose the ERF.³

This article outlines the main features of the proposed ERF, as set out in the White Paper.

Emissions reduction project

The first step in selling emissions reductions to the ERF will be to have an emissions reduction project registered with the Clean Energy Regulator. A project will be registered by the Clean Energy Regulator if:

• it is covered by an approved method;
• the project proponent meets basic probity requirements; and
• the project proponent has the legal right to undertake the project.

Broadly speaking there will be two categories of methods:

• activity methods for specific emissions reduction activities (eg forest/soil sequestration, commercial lighting, coal mine waste gas destruction etc); and
• facility-wide methods, which will credit aggregate improvements in the emissions-intensity of large facilities (such as power stations, cement and aluminium production facilities, and oil and gas extraction plants) using data reported under the National Greenhouse and Energy Reporting Scheme (NGERS).

The Environment Minister will prioritise the development of methods, which will be developed by technical working groups (comprising business and government representatives), assessed by the Emissions Reduction Assurance Committee (which will replace the Domestic Offsets Integrity Committee under the Carbon Farming Initiative (CFI)) and subject to public consultation. In determining the priorities for the development of methods (or at least activity methods), the Minister will take into account the potential uptake of the method and likely volume of emissions reductions, whether the emissions reductions can be estimated with a reasonable degree of certainty and at an acceptable cost, whether the activity could have adverse social, environmental or economic impacts,⁴ and whether the activity could be provided more effectively through other government measures (eg the renewable energy target). The focus will be on developing methods that are broadly applicable (eg a metered baseline methodology that is capable of applying to a wide range of energy efficiency activities) rather than tailored to a specific project. Approved methods will include those currently used under the CFI, and are expected to draw heavily on methods used in other schemes (such as the NSW Energy Savings Scheme and the Clean Development Mechanism).

The methods will specify how emissions reductions are to be measured, verified and credited, and will include requirements intended to ensure that the resultant emissions reductions are additional (that is, would not have occurred in the absence of the ERF). It is anticipated that additionality could be secured through methods that, for instance, credit improvements in emissions-intensity (eg as a result of improved practices or technology), require the establishment of an 'alternative emissions scenario' (ie a business-as-usual scenario) against which emissions reductions achieved by the project are measured, or apply to activities that are beyond common practice.⁵ Additionality is also intended to be secured through:

• excluding projects that are implemented before they have been registered with the Clean Energy Regulator;⁶
• crediting projects for a single 'crediting period', being the period over which the project is likely to deliver additional emissions reductions – this crediting period will generally be seven years but may be three years (for activities that are likely to quickly become business-as-usual, eg space heating), ten years (for emissions reduction projects that are likely to have additionality beyond seven years and to deliver on average more than 250ktCO₂-epa of emissions reductions) or 15 years (for reforestation and soil carbon projects);
• the periodic review (at least once every four years) of methods, although any change to a method would not affect existing projects that use the method;
• excluding emissions abatement activities that are required by law; and
• excluding projects to the extent they are funded by another government program (eg the NSW Energy Savings Scheme), although this is not intended to exclude activities that receive only indirect or limited financial benefits through other government initiatives.

Technical working groups are currently developing methods for coal mine gas capture, transport technology upgrades/low emission vehicles, landfill gas capture, alternative organic waste treatment, methane capture at waste water facilities, industrial energy efficiency and commercial building efficiency. Other priority areas for method development include soil carbon, livestock emissions, environmental and carbon sink plantings, reforestation and avoided deforestation. Together with existing CFI methodologies this is anticipated to mean that around 30 methods will be available when the ERF commences.

While there is a wide range of emissions abatement activities that could potentially be the subject of methods for the purposes of the ERF, non-Kyoto activities will no longer be credited as they do not count towards Australia's Kyoto Protocol target.

It is intended that emissions reductions will be estimated in accordance with the requirements of the National Greenhouse and Energy Reporting Measurement Determination or, in the case of sources not covered by NGERS (eg agricultural emissions), methods that are consistent with those used to compile Australia's National Greenhouse Gas Inventory. The establishment of facility-wide methods raises some issues that will need to be addressed in this regard. The integrity of emissions reductions at the facility level will very much depend upon the establishment of an appropriate facility-level baseline against which emissions reductions can be assessed. This is likely to be quite challenging, as the chosen baseline (which will need to be established by reference to historical emissions) will need to be normalised so as to remove any unrepresentative data and to ensure that only below-baseline emissions that derive from improvements in technology or practices are credited. Raw NGERS data is not of itself sufficient for this purpose because it merely reflects actual historical outcomes. If the assigned baselines are too generous, there is a risk that 'false' (cheap) emissions reductions will displace real (more expensive) emissions reductions as those which are purchased by the ERF.

Project proponents will also be required to submit to the Clean Energy Regulator (at intervals of between six months and two years ), reports that detail the emissions reductions achieved by their projects.⁷ These emissions reductions will potentially need to be verified by an independent auditor registered under NGERS. For these purposes the Clean Energy Regulator will apply a risk-based approach, ie the level, frequency and scope of the verification will depend on the risks associated with both the project and the project proponent. In addition, the Regulator will have the power to conduct ad hoc audits or to require a compliance audit to be undertaken where potential instances of non-compliance have been identified.

The Clean Energy Regulator will issue Australian carbon credit units (ACCUs) for measured (and, if necessary, verified) emissions reductions from registered projects.⁸

Bidding of emissions reductions into ERF

The next step in selling emissions reductions to the ERF will be to bid emissions reductions from the registered project into the ERF.

The remit of the ERF is to purchase emissions reductions at the lowest available cost. This means that the government has eschewed mechanisms such as 'banding'. In order to fulfil this remit, the Clean Energy Regulator will conduct periodic auctions⁹ at which the proponents of registered projects can bid emissions reductions from those projects into the ERF provided:

• the pre-qualification requirements to participate in the auction are satisfied; and
• the project is registered for the auction.

The pre-qualification requirements are intended to ensure that the relevant project is capable of generating the emissions reductions so that they can be purchased by the Fund on the auction terms and conditions (see below). As such, the Clean Energy Regulator will check the identity, probity and capability of the project proponent (taking into account any previous compliance issues), the project's consistency with an approved method, the project proponent's legal right to undertake the project, the commercial readiness of the project and the credibility of the project proponent's emissions reduction estimates. The auction registration requirement is designed to ensure that the Clean Energy Regulator knows how many bidders are likely to participate in the auction. This is necessary because an auction will not be permitted to proceed unless there is a minimum number of bidders and a minimum quantity of emissions reductions. As such, one of the registration requirements will be the submission of a proposed schedule of emissions reductions from that project that are to be bought by the ERF.

Each registered bidder will be able to submit one sealed bid that specifies a single price per tonne for emissions reductions from the relevant project. The Clean Energy Regulator will set an undisclosed¹⁰ benchmark price for the auction (ie the maximum amount it will pay), having regard to factors such as the overall objective of achieving low-cost emissions reductions, the observed cost per tonne of emissions reductions in projects previously bid at auction, the amount of funding allocated at previous auctions and emissions reductions required to meet the five per cent target. In order to stimulate competition and meet the lowest-cost criterion, the Fund will buy the lowest priced 80 per cent of emissions reductions below the benchmark price¹¹ (subject to any budget allocated by the Clean Energy Regulator to the auction being sufficient for this). Successful bidders will be paid the price they bid rather than any auction clearing price. There will be an initial minimum bid size of 2,000tCO₂-epa on average over the life of the contract.¹²

Successful bidders will be required to enter into a standardised emissions reduction sale contract with the Clean Energy Regulator (on behalf of the Commonwealth) which:

• sets out the schedule for payment and delivery (quantity/timing) of the emissions reductions (in the form of ACCUs);¹³
• includes conditions relating to the provision of project finance and granting of any necessary regulatory approvals (eg. planning or environmental approvals), with the Clean Energy Regulator being able to terminate the contract if these conditions are not met within a reasonable time period;
• permits the project proponent to transfer the contract to another emissions reduction provider with the Clean Energy Regulator's consent, and to grant security over the contract for the purpose of raising finance for the project; and
• includes a make-good obligation under which the project proponent must make up any shortfall in delivery through delivering ACCUs from another source (but at the contract price), failing which liquidated damages may be payable.

Importantly, the ERF will only pay for emissions reductions (ACCUs) that are actually delivered; there will be no provision for forward-payment.

Somewhat controversially the Government has also retained its preference for a five year contract period. This is significant because most projects will have a longer crediting period and so the ERF will not provide a guaranteed offtake for all of the project's emissions reductions (moreover, a project that has been successful at auction will not be able to participate in a subsequent auction). This means that project proponents will not be able to rely on the ERF to take all their emissions reductions; they will have to look elsewhere (eg to the voluntary market or auction participants who are subject to a make good requirement) to sell their 'excess' emissions reductions. Whether there will be sufficient, relatively certain demand for these emissions reductions so as to make the overall project viable is a matter that is far from clear. Having said this, the Government proposes to appoint a consultant to undertake 'targeted market testing' of the proposed contractual terms, including the contract period, before the first auction and so this requirement might change. There are likely to be different standardised contracts for aggregators (see later) and, possibly, for those who merely wish to sell already created ACCUs into the auction.

In its Green Paper, the Government suggested that 'very large' projects could be assessed through a process separate to the periodic auctions. The White Paper provides some further detail in this regard, stating that the Clean Energy Regulator will be given the flexibility to use different types of procurement and tendering processes, and that the Government will retain discretion to enter out-of-auction contracts for major projects which can deliver more than 250ktCO₂-epa in emissions reductions (on average)¹⁴ or 1.25 MtCO₂-e in emissions reductions over the contract period.

Emissions safeguard mechanism

The Green Paper contemplated that there would be a 'safeguard mechanism' to incentivise businesses not to increase their emissions above historical levels, but was quite vague as to the nature of any compliance obligation that might attach to the mechanism. Unfortunately the White Paper does not provide much further clarity as to this matter. According to the White Paper:¹⁵

The safeguard mechanism will protect taxpayer funds by ensuring that emissions reductions paid for through the Emissions Reduction Fund are not displaced by a significant rise in emissions elsewhere in the economy.

What is known is that the safeguard mechanism will commence on 1 July 2015, will apply to direct (as opposed to indirect or embodied) emissions, will apply only to facilities (not companies) with direct emissions of 100ktCO₂-epa or more, and will operate where the facility's absolute emissions exceed a baseline that is set at the highest level of reported emissions for the facility over the years 2009/10 to 2013/14.

The Government itself recognises that this is an extremely 'generous' approach, regarding exceeding the baseline as an 'unlikely event'.¹⁶ However, two important aspects of the safeguard mechanism remain outstanding. The first is the consequences of exceeding the baseline. In a further sign that the Government does not intend the safeguard mechanism as anything like an emissions cap, the White Paper foreshadows 'flexible compliance options', which may entail an exemption for facilities where their emissions intensity (as opposed to their absolute emissions production) is not rising, using a multi year average of emissions as the comparator against the baseline and/or the ability to meet any shortfall by purchasing offsets. The second outstanding aspect is the treatment of new investments and significant expansions. In this regard the White Paper flags the possibility of setting the baseline by reference to industry 'best practice', as well as the need to accommodate any emissions intensive ramp up phase and projects for which a final investment decision has already been made when the safeguard mechanism is introduced (there being less scope to change the design of such projects after that time). These matters are to be the subject of on-going consultation, with exposure draft legislation for the emissions safeguard mechanism to be released in the first quarter of next year. The White Paper also notes representations from the electricity industry that it should be exempt from the safeguard mechanism because the industry is subject to the renewable energy target and because generation output is largely dictated by the operation of the national electricity market despatch arrangements; however, it merely states that the Government will continue to consult with the electricity industry on the specific application of the safeguard mechanism to it.

The absence of a credible emissions constraint is of some concern. The White Paper itself acknowledges that Australia's emissions are projected to grow to around 685MtCO₂-e by 2020, with the largest contributors being LNG and coal production, but transport and industrial process emissions also growing. In this context, the fact that the safeguard mechanism lacks any real 'bite', and that it only covers approximately 52 per cent of Australia's emissions, suggests that it is unlikely to be very effective at all in ensuring that emissions reductions purchased by the ERF are not simply cancelled out by emissions increases in other sectors of the economy. The current review of the renewable energy target is also relevant in this respect. The White Paper acknowledges the role of the target in limiting the growth of emissions from energy generation to 2020, but also recognises that Australia's projected emissions growth from 2020 to 2030 (to 801MtCO₂-e in 2030) will be dominated by emissions from electricity.

Other matters

The aggregation of smaller projects for the purposes of the creation of emissions reductions and bidding into the ERF will be encouraged:

• in the case of land-based projects, by requiring the project proponent merely to show that it has the agreement of the landholders to undertake the project rather than that it owns (or has some kind of interest in) all of the properties on which the project is being undertaken; and
• in the case of emissions reduction activities at the household and small business level (eg energy efficiency projects), by allowing the transfer of the benefit of emissions reductions relating to those activities from the household/small business to a project aggregator.

A number of modifications will also be made to the CFI. One of the most significant of these is to permit sequestration projects (forestry, revegetation and soil carbon) to choose a 25 year (rather than 100 year) permanence option, with the number of ACCUs issued for such projects being discounted by an additional 20 per cent. This is quite separate from the risk of reversal buffer of 5 per cent, which will continue to apply to sequestration projects irrespective of whether they opt for the 25 year or 100 year permanence option.

Finally, the White Paper states that the Government will conduct a 'targeted review' of the ERF towards the end of 2015 that will focus on operational elements, such as the conduct of auctions and method development, as opposed to more fundamental design elements. Suggesting that the ERF might possibly have a longer life than many had thought, the White Paper states that the findings of this review will inform the structure of the ERF post 2020.¹⁷

Next steps

Although funds for the ERF will be allocated in the budget legislation (making it unlikely to be blocked by the Senate), the Government will need to introduce other legislation to establish the ERF, including to expand (and regulate) the powers of the Clean Energy Regulator in relation to the ERF, to set out certain key features of the ERF (such as how historical baselines are set and credits are calculated), and to modify the CFI and NGERS to accommodate the ERF. Exposure draft legislation for this purpose will be released before 1 July 2014.