Emissions Reduction Fund Exposure Draft Legislation Released

In brief

The Federal Government has released exposure draft legislation for the establishment of its proposed Emissions Reduction Fund. Partner Grant Anderson and Lawyer Albert Yu report.

Background

Following hot on the heels of its White Paper on the design of the Emissions Reduction Fund (the ERF) (see Allens Focus: Emissions reduction fund white paper released), the Federal Government has now released exposure draft legislation for the ERF. The ERF is to be established by expanding the existing Carbon Farming Initiative (the CFI), which is set up under the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) (the CCA)¹ and currently enables land-based carbon abatement and sequestration projects to generate tradeable carbon credits (emission reductions) in the form of Australian carbon credit units (ACCUs) (see Allens Focus: Carbon Farming Initiative legislation passed). The primary remit of the ERF is to forward-contract for the purchase of ACCUs from qualifying emissions reduction projects, with the ERF selecting the emissions reductions that it will purchase on the basis of least cost as determined by periodic reverse auctions or other competitive tendering processes. As well as increasing the range of projects that will be able to generate ACCUs for this purpose, the exposure draft legislation also seeks to streamline the administration of the CFI in a number of respects.

While the exposure draft legislation gives effect to the design of the ERF as set out in the White Paper, whether the legislation will be passed by Parliament (either in the form currently proposed or at all) remains unclear. If Labor and the Australian Greens maintain their opposition to the ERF after the new Senators take their seats on 1 July 2014, then the Government will need to rely on the support of six of the eight micro party Senators in the new Senate; however, this support cannot be taken for granted.

The recent Commonwealth budget also highlights the uncertainty that will continue to dog a scheme that relies on annual budgetary appropriations. While the White Paper committed $2.55 billion of funding to the ERF, which was said to be an increase on the $1.55 billion previously promised for the first three years of its operation, the budget only provides for $730 million of funding for those three years (with a further $417 million for 2017/18). Moreover, it has now been revealed that the $2.55 billion actually represents the amount the Government is willing to invest in the ERF for the 10-year period from 1 July 2014.² Although funds will not be required from the ERF until the carbon abatement purchased by the ERF is actually delivered, it is essential that there is funding certainty because it will be necessary to know what funding is available before the ERF can actually commit to enter into contracts for the forward-purchase of that carbon abatement. Among other things, the amount of funding available will be a critical determinant of the volume of carbon abatement that can be bought at the reverse auctions.

This is in a context where budgetary decisions such as the abolition of renewable energy project funding by the Australian Renewable Energy Agency, as well as the likely scaling back of the mandatory renewable energy target scheme, mean that the ERF will need to make a correspondingly greater contribution to emissions reductions if Australia is to meet its commitment to reduce its greenhouse gas emissions to 5 per cent below 2000 levels by 2020. The magnitude of this task will be greater to the extent that Australia may be required to adopt tighter emissions reductions targets as part of a future international climate change agreement.

Emissions Reduction Fund

One of the new objects of the CCA will be to 'authorise the purchase by the Commonwealth of units that represent carbon abatement'³. These units are referred to as 'eligible carbon credit units'⁴, which may be Kyoto-compliant ACCUs, or other prescribed units,⁵ that represent carbon abatement that is able to be used to meet Australia's climate change targets under the Kyoto Protocol or any successor international agreement.⁶ As such, the Clean Energy Regulator (the Regulator) will be authorised (on behalf of the Commonwealth) to enter into 'carbon abatement contracts' for the purchase of eligible carbon credit units as a result of a 'carbon abatement purchasing process' conducted by the Regulator.⁷ A carbon abatement purchasing process is not limited to the reverse auctions (which are contemplated as being the mechanism by which the ERF will contract for the forward-purchase of carbon abatement at auction), but extends to tenders and 'any other' processes⁸. This will, for example, enable the Regulator to enter into out-of-auction contracts for major projects⁹. The principles that are to guide the purchase of such carbon abatement include that¹⁰:

• the carbon abatement should be purchased at the least cost; and
• the amount of carbon abatement that can be purchased 'within allocated resources' should be maximised.

After undertaking a carbon abatement purchasing process, the Regulator must publish the weighted average price for eligible carbon credit units that the Commonwealth is purchasing as a result of the process¹¹. Moreover, for every financial year, the Regulator must publish the total amount of carbon abatement purchases under carbon abatement contracts entered into during that year, the total amount that the Commonwealth is liable to pay for such abatement, the total number of eligible carbon credit units that are transferred to the Commonwealth during that year as a result of carbon abatement contracts, and the total amount paid by the Commonwealth during that year to purchase eligible carbon credit units under carbon abatement contracts¹². The Regulator must also record in the Emissions Reduction Fund Register (the previous Register of Offsets Projects) the details of carbon abatement contracts that have been entered into, including the name of the counterparty, the duration of the contract, the name of the project that is to generate the eligible carbon credit units, and the number of eligible carbon credit units that have been and are to be sold to the Commonwealth under the contract¹³.

Qualifying projects

For a project to qualify under the current CFI, it must first be declared by the Regulator, on the application of the project proponent, to be an 'eligible offsets project'. This concept will be retained under the ERF, but with certain changes. While the project must still be one that is carried out in Australia and is covered by a methodology determination:

• the project proponent will be required to pass the 'fit and proper person' test; and
• the project will be required to meet prescribed 'additionality' requirements.

The 'fit and proper person' test will replace the concept of a 'recognised offset entity'. While a recognised offset entity has to satisfy the criterion of being a 'fit and proper person', the exposure draft legislation provides that¹⁴:

• fitness and propriety is to be determined having regard to matters that are to be specified in legislative rules (instead of by reference to the existing long list of offences);
• an individual will not be a fit and proper person if they are an insolvent under administration; and
• a body corporate will not be a fit and proper person if they are subject to external administration.

The additionality requirements comprise three cumulative requirements¹⁵:

• the 'newness requirement' – the project must not have begun to be implemented before it has been declared to be an eligible offsets project¹⁶;
• the 'regulatory additionality requirement' – the project must not be required to be carried out under an Australian law; and
• the 'government program requirement' – the project must be unlikely to be carried out under another Australian government program or scheme if it was not declared to be an eligible offsets project.

Individual methodology determinations may provide replacement requirements for any of these tests¹⁷. These additionality requirements will replace the current 'positive list' that prescribes projects that are considered to be additional on the basis that they are not 'common practice'.

The categories of projects that will be able to be declared to be eligible offsets projects comprise:

• Area-based offsets projects, which comprise sequestration offsets projects and area-based emissions avoidance projects. Sequestration offsets projects are currently recognised under the CFI and are projects that remove carbon dioxide from the atmosphere by sequestering carbon in living biomass, dead organic matter or soil, eg forestry and soil biosequestration¹⁸. Area-based emissions avoidance projects are to be prescribed by legislative rules¹⁹ and could conceivably include projects such as savanna fire management²⁰.
• 'Emissions avoidance offset projects', which comprise the current agricultural emissions avoidance projects (eg projects to avoid emissions from livestock) and landfill legacy emissions avoidance projects, as well as a new category of 'any other project to avoid emissions of greenhouse gases'²¹. This last category will be the principal basis for expanding the CFI from a land-based carbon abatement scheme to a broader scheme that encompasses projects such as commercial building upgrades, improved energy efficiency, reduced electricity generation emissions, landfill and waste coal mine gas capture and destruction, and vehicle upgrades.²² 

However, only projects that result in carbon abatement which can be used to meet Australia's climate change targets under the Kyoto Protocol or a successor international agreement will qualify as eligible offsets projects. This means that non-Kyoto compliant emissions reduction projects, such as the management of wetland areas and feral animal management (ie the current 'introduced animal emissions avoidance projects'), will no longer qualify to generate ACCUs. In addition, the concept of 'excluded offsets projects' (ie the 'negative list') is being retained so that projects, such as the avoidance of harvesting a plantation, will not qualify as eligible offsets projects.

In so far as sequestration offsets projects are concerned, the project proponent will be able to irrevocably elect for the project to be either a 25-year permanence period project or a 100-year permanence period project. The difference is that while, for both kinds of projects, the net abatement number that is used to calculate the number of ACCUs to be issued for the project for the reporting period will be reduced by a 'risk of reversal' buffer number of 5 per cent²³ of the net abatement number, 25-year permanence period projects will also incur a further 'permanence period discount' of 20 per cent²⁴ of the net abatement number.²⁵

The project proponent must be the person who is responsible for carrying out the project and must have the legal right to carry out the project.²⁶ The current requirement for the project proponent for a sequestration offsets project to hold the applicable sequestration right will be removed. This will facilitate the aggregation of such projects under a project proponent who conducts the project with the agreement of the landowners who hold those rights. However, the project proponent will need to have obtained the consent of the holders of the relevant carbon sequestration rights (this is in addition to the existing requirement to obtain the consent of other persons such as those who hold a registered estate or interest in the land, mortgagees and chargees etc).²⁷

A project is currently defined to include 'a set of activities', which already accommodates the aggregation of projects that comprise a number of different abatement activities that are covered by a single methodology determination. However, the exposure draft legislation provides for further flexibility by:

• allowing project proponents to report on, and receive ACCUs from, different parts of a project;²⁸ and
• streamlining the information provision requirements that are common to projects (including those that are covered by different methodology determinations) so as to avoid duplication in the registration, reporting and ACCU issuance processes.

Crediting periods

The current CFI provides for eligible offsets projects to be granted successive subsequent crediting periods. However, under the exposure draft legislation, new eligible offsets projects will only have one crediting period and existing projects will be entitled to a second crediting period.²⁹ Unless a different crediting period is specified in the applicable methodology determination, this crediting period will be seven years for emissions avoidance offsets projects and 15 years for sequestration offsets projects (native forest protection projects, which are currently entitled to only one crediting period of 20 years, will also be subject to these new arrangements). The purpose of a single crediting period is to ensure that the ERF funds new projects on a rolling basis³⁰.

Reporting, auditing and issuing of ACCUs

Project proponents will continue to be required to provide offsets reports to the Regulator for every reporting period, which will be between six months (rather than 12 months) and five years.³¹ However, where the ACCUs are to be forward-purchased by the ERF, the carbon abatement contract is likely to provide for the delivery of ACCUs at least once every two years, in which case offsets reports will need to be provided on a periodic basis which is consistent with such scheduled deliveries³². An offsets report will only need to be accompanied by an audit report if the legislative rules so require³³ or if the Regulator has notified the project proponent that its offsets report must be audited (such a notification must only be given if the Regulator is satisfied that this is appropriate having regard to effective risk management)³⁴.

The exposure draft legislation retains the requirement for a certificate of entitlement, which is to specify the number of ACCUs that represent the measured (and, if necessary, verified) carbon abatement from the project for the reporting period. The Regulator is required to issue this number of ACCUs to the project proponent. These ACCUs will be issued into the project proponent's account with the Australian National Registry of Emissions Units. In order to be issued with the ACCUs, the project proponent must pass the 'fit and proper person' test.

Methodology determinations

The Minister will be empowered to make or vary methodology determinations that apply to offsets projects (the number of ACCUs that are to be issued in respect of a project for a reporting period is calculated using the methodology determination). However, whereas under the current CFI a person could apply to the Domestic Offsets Integrity Committee for endorsement of a proposal to make or vary a methodology determination, under the exposure draft legislation it will be the Minister who 'drives' this process. In this regard, the Minister is required to request advice from the new Emissions Reduction Assurance Committee (which will supersede the Domestic Offsets Integrity Committee) before making or varying a methodology determination, and to have regard to that advice (the Minister can also direct the Committee, by legislative instrument, about the matters to which the Committee must have regard in providing advice to the Minister)³⁵. In addition, in making or varying a methodology determination, the Minister must have regard to:

• the offsets integrity standards, which include that the carbon abatement is unlikely to occur in the ordinary course of events (this looks like another 'additionality' requirement) and must be measurable and verifiable³⁶; and
• whether there are likely to be any adverse environmental, economic or social impacts³⁷ (unlike the current CFI, this assessment will be made at the methodology determination stage rather than for individual projects, although such projects will still need to obtain any applicable regulatory approvals).

There will no longer be any requirement that a methodology must include a baseline (because the methodologies are not intended to be project-specific), be consistent with National Greenhouse and Energy Reporting Scheme (NGERS) estimation methods (because in some cases there may be more accurate estimation methods that have not been included in the NGERS measurement methods), or supported by relevant scientific results published in peer-reviewed literature (it is sufficient if the methodology is supported by 'clear and convincing' evidence, which may include much scientific evidence).

Although not specifically stated in the exposure draft legislation, the Minister will request that the Emissions Reduction Assurance Committee reviews methodology determinations at least every four years so as to ensure that the methodologies continue to result in genuine and additional emissions abatement, taking into account factors such as changing market conditions³⁸.

Other matters

The exposure draft legislation contains a number of transitional provisions that will need to be carefully examined by existing CFI project proponents to ensure that their projects are able to be properly transitioned to the new ERF arrangements. These transitional provisions include provision for the grandfathering of existing CFI projects and methodologies (including their current crediting period), and the continuing issue of non-Kyoto ACCUs for existing non-Kyoto CFI projects.

It will also no longer be possible to have ACCUs automatically cancelled, eg as where the customers of a business pay for the emissions reductions. The explanation offered for this is that such a mechanism is 'no longer required, and companies that were expected to use [this mechanism] have adopted new business models'.³⁹

Finally, while the exposure draft legislation sets out many of the principal design features of the ERF, much of the detail has been left to legislative rules, Ministerial directions, the auction rules and methodology determinations. This includes how baselines will be set and, in particular, how normalised baselines for facility-wide methodologies are to be established. In addition, as the Federal Government has previously foreshadowed, one key design feature of the ERF – the safeguard mechanism (see 'Emissions safeguard mechanism' section of Allens Focus: Emissions reduction fund white paper released) – has yet to be developed. This will be the subject of further consultation ahead of its proposed introduction on 1 July 2015. There is therefore a lot more work that remains to be done to operationalise the ERF.

Next steps

Submissions on the exposure draft legislation are due by midday on 23 May 2014. If you would like any further information, or assistance in drafting your submission, please contact any of the people below.