Senate passes Emissions Reduction Fund legislation

In brief

The Senate has passed legislation for the establishment of an emissions reduction fund to purchase carbon abatement, which also includes a framework for a safeguard mechanism under which large emitting facilities may be penalised for exceeding their emissions baseline. Partner Grant Anderson and Lawyer Daniel Coelho report.

Background

Following a consultation process that involved the release of a Green Paper late last year, a White Paper in April and exposure draft legislation in May, the Federal Government introduced into Parliament legislation for the establishment of its proposed Emissions Reduction Fund (ERF) in June. However, the legislation was delayed in the Senate while the Government negotiated amendments to it with the crossbench senators so as to enable the legislation to be passed despite it being opposed by the Opposition and Australian Greens senators. The Senate has now passed the legislation, which will come into operation after the agreed amendments are approved by the House of Representatives, which is expected to be in late November.

With the repeal of both the Australian carbon pricing scheme and the energy efficiency opportunities program earlier this year, and the likelihood that the renewable energy target scheme will be wound back to some extent, the ERF is the principal policy instrument that the Federal Government is relying on to meet the current target of reducing Australia's greenhouse gas emissions to 5 per cent below 2000 levels by 2020. Whether the ERF will in fact be capable of eliciting the required amount of carbon abatement to meet this target is another matter, particularly as the Government has capped the funds available to the ERF for this purpose at $2.55 billion.

The ERF is an expanded version of the existing Carbon Farming Initiative and is established through amendments made to the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) (the CCA). Under the ERF, qualifying carbon abatement projects are able to generate tradeable carbon credits (emission reductions) in the form of Australian carbon credit units (ACCUs), which can be forward-purchased by the ERF by way of periodic reverse auctions or other competitive tendering processes. The carbon abatement that can be purchased by the ERF is limited to that which can be used to meet Australia's climate change targets under international agreements such as the Kyoto Protocol. At least initially this carbon abatement will take the form of 'Kyoto ACCUs',¹ but provision is also made for the ERF to purchase other carbon units that may in the future be prescribed by regulations.² 

Emissions Reduction Fund

The ERF will be administered by the Clean Energy Regulator (the Regulator). As such, the Regulator is authorised (on behalf of the Commonwealth) to enter into 'carbon abatement contracts' for the purchase of ACCUs where those contracts are the result of a 'carbon abatement purchasing process' conducted by the Regulator.³ Reverse auctions, which are expected to be the primary mechanism by which the ERF will contract for the forward-purchase of carbon abatement, are one form that a carbon abatement purchasing process may take; however, carbon abatement purchasing processes also extend to tenders and 'any other' processes.⁴ So, for example, the Regulator is empowered to enter into out-of-auction contracts for major projects.⁵ Whichever approach is adopted, the principles that are to guide the purchase of such carbon abatement include that:⁶

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

The Regulator must publish, for every financial year:

• the total amount of carbon abatement agreed to be purchased 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 ACCUs 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 ACCUs under carbon abatement contracts.⁷

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 ACCUs and the number of ACCUs that have been and are to be sold to the Commonwealth under the contract.⁸ The purchase price of ACCUs under a carbon abatement contract is confidential and will not be disclosed; however, after undertaking a carbon abatement purchasing process, the Regulator may publish the weighted average price for the ACCUs that it has agreed to purchase as a result of the process.⁹

The Regulator has released a discussion draft carbon abatement contract that successful bidders into the ERF will be required to enter for the sale of the ACCUs from their project to the Regulator. In accordance with the CCA, the term of this contract should generally not be longer than seven years (the crediting period for most emissions avoidance offsets projects) unless the relevant project has a crediting period of greater than seven years¹⁰ (as will be the case with sequestration and savanna burning projects) (see later section 'Crediting periods'). This will assist project proponents by enabling them to bid into the ERF the full quantity of ACCUs generated by their projects.

It is anticipated that the first auction under the ERF will be held in the first quarter of next year.

Qualifying carbon abatement projects

As stated above, for a project to qualify as one that can bid to sell its carbon abatement (ACCUs) to the ERF, that project must result in carbon abatement that can be used to meet Australia's climate change targets under international agreements such as the Kyoto Protocol.¹¹ In addition, the project must be declared by the Regulator (on the application of the project proponent) to be an 'eligible offsets project'.¹² This means that:

• the project must be carried out in Australia;¹³
• the project must be covered by a methodology determination;¹⁴
• the project proponent must pass the 'fit and proper person' test;¹⁵ and
• the project must meet prescribed 'additionality' requirements.¹⁶

For the purposes of the 'fit and proper person' test:¹⁷

• fitness and propriety is to be determined having regard to matters that are to be specified in legislative rules;
• 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 requirements:¹⁸

• The 'newness requirement' – the project must not have begun to be implemented before it has been declared to be an eligible offsets project. By way of example, a project will have begun to be implemented if it has been the subject of a final investment decision, a tangible non-land asset (other than a minor asset) has been acquired or leased for use wholly or mainly for the purposes of the project, construction work has commenced or (in the case of a sequestration offsets project) soil preparation, seeding, planting or fertilisation has been undertaken or irrigation or drainage systems have been installed. Conversely, the undertaking of a feasibility study, planning or design, the obtaining of regulatory approvals or consents, the conduct of negotiations or sampling to establish a baseline will not constitute implementation of the project. Nonetheless, in certain circumstances, a project proponent is able to commence the project after 1 July 2014 but before its declaration as an eligible offsets project without breaching the 'newness' requirement. In order to take advantage of this exception, the project proponent must notify the Regulator, during the period between 1 July 2014 and the date of the commencement of the ERF, that the project proponent intends to make an application to the Regulator to have the project declared to be an 'eligible offsets project' under the CCA, and must formally apply for such a declaration by 1 July 2015. The project proponent can then commence implementation of the project after the date the notification is given to the Regulator (and before the date the project is declared to be an eligible offsets project) without disqualifying the project under this requirement.¹⁹
• The 'regulatory additionality requirement' – the project must not be required to be carried out under an Australian law.
• The 'government program requirement' – the project must be unlikely to be carried out under another Australian government program or scheme if it were not declared to be an eligible offsets project. However, this requirement is not intended to prevent a project proponent from obtaining funding or in-kind support from multiple sources where this is necessary for the project. For example, the Government anticipates that environmental planting projects could receive assistance from the Green Army and that fire management projects may involve rangers who are supported under Indigenous ranger programs.²⁰ It is intended that the Regulator will issue guidelines that list government programs that typically provide sufficient funding for emissions reductions activities, and that consequently would cause a project not to satisfy the government program requirement if it receives funding under those programs. The Government has cited the New South Wales Energy Savings Scheme as an example of such a government program.²¹

Individual methodology determinations may provide replacement requirements for the newness and regulatory additionality requirements, and legislative rules may provide replacement requirements for the government program requirement.²²

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

• Area-based offsets projects, which comprise sequestration offsets projects and area-based emissions avoidance projects. Sequestration offsets projects are projects that remove carbon dioxide from the atmosphere by sequestering carbon in living biomass, dead organic matter or soil, eg forestry and soil biosequestration.²³ Area-based emissions avoidance projects are to be prescribed by legislative rules.²⁴
• 'Emissions avoidance offset projects'²⁵, which comprise agricultural emissions avoidance projects (eg projects to avoid emissions from livestock or savanna burning),²⁶ landfill legacy emissions avoidance projects,²⁷ and 'any other project to avoid emissions of greenhouse gases'.²⁸ This last category may include 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.²⁹

However, certain projects ('excluded offsets projects'), such as the avoidance of harvesting a plantation, will not qualify as eligible offsets projects.³⁰

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.³¹ 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 cent³² of the net abatement number, 25-year permanence period projects will also incur a further 'permanence period discount' of 20 per cent³³ of the net abatement number.³⁴ In certain circumstances, a reversal of the carbon sequestration will result in the project proponent being required to relinquish a corresponding number of ACCUs, and a failure to do so may result in a carbon maintenance obligation being imposed on the land for the purpose of regulating activities on the land so as to preclude a further diminution in the sequestered carbon (such an obligation will be lifted on the relinquishment of the requisite number of ACCUs).³⁵

The project proponent is the person who is responsible for carrying out the project, and must be the person who has the legal right to do so.³⁶ In the case of a sequestration offsets project, the project proponent does not need to hold the applicable carbon sequestration rights but will need to have obtained the consent of the holder of those rights (this is in addition to the requirement to obtain the consent of other interested persons, such as those who hold a registered estate or interest in the land, mortgagees and chargees etc).³⁷

Crediting periods

Eligible offsets projects will only have one crediting period (although, as a transitional measure, existing projects will generally be entitled to a second crediting period). 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 25 years for sequestration offsets and savanna burning projects.³⁸ The purpose of a single crediting period is to ensure that the ERF funds new projects on a rolling basis.³⁹ The Emissions Reduction Assurance Committee (see later section 'Methodology determinations') is required to review the duration of the crediting period allowed under each methodology determination at least 12 months before the expiry of the first actual crediting period under that determination, having regard to the requirement that a methodology requirement should result in carbon abatement that is unlikely to occur in the ordinary course; if the outcome of this review is that the crediting period allowed under the determination should be extended, then (and only then) may the Minister amend the determination to apply this extended crediting period.⁴⁰ This will enable projects that are still achieving additionality to continue to generate ACCUs, even though they will not be able to sell that abatement into the ERF if the term of the carbon abatement contract is less than the extended crediting period.

Project proponents may nominate the start of the crediting period for their project, which must be within 18 months of project declaration.⁴¹ This is designed to enable project proponents to align the start of their crediting period with the start of their project, given that there could be a significant period between project declaration and commencement (particularly for large or complex projects).⁴²

Reporting, auditing and issuing of ACCUs

A reporting period is generally a subset of the applicable crediting period.⁴³ Project proponents must provide offsets reports to the Regulator for every reporting period, which will be between six months (or less if prescribed by legislative rules), on the one hand, and two years (for emissions avoidance offsets projects) and five years (for sequestration offsets projects), on the other hand.⁴⁴ 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 deliveries.⁴⁵ An offsets report will only need to be accompanied by an audit report if the legislative rules so require⁴⁶ 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).⁴⁷

After the end of the reporting period, and on an application to the Regulator (which must be accompanied by the offsets project report, audited if required), the Regulator will issue to the project proponent a certificate of entitlement.⁴⁸ This certificate specifies the number of ACCUs that represent the carbon abatement from the project for the reporting period, and the Regulator must issue this number of ACCUs to the project proponent.⁴⁹ These ACCUs will be issued into the project proponent's account with the Australian National Registry of Emissions Units.⁵⁰ In order to be issued with the ACCUs, the project proponent must pass the 'fit and proper person' test.⁵¹ Offsets reports and applications for certificates of entitlement may be made in respect of parts of a project, so that ACCUs can be issued separately for those different parts.⁵²

Methodology determinations

The offsets project declaration must specify the methodology determination for the project.⁵³ The methodology determination is used to calculate the number of ACCUs that are able to be issued in respect of the project for a reporting period. The Minister is empowered to make or vary methodology determinations that apply to offsets projects. For this purpose, the Minister must request advice from the Emissions Reduction Assurance Committee (the successor to the Domestic Offsets Integrity Committee) before making or varying a methodology determination, and must 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).⁵⁴ The Committee is required to consult on any proposal to make or vary a methodology determination.⁵⁵ 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 and must be measureable and verifiable;⁵⁶ and
• whether there are likely to be any adverse environmental, economic or social impacts as a result of the kind of project to which the determination applies.⁵⁷

Any person can request the Committee to review a methodology determination.⁵⁸

In addition to the current Carbon Farming Initiative methodology determinations, a number of draft ERF-related methodology determinations have been released for public consultation. These include both activity-specific methodology determinations (eg for wastewater treatment, commercial building efficiency, transport and coalmine waste gas) and a facility-wide methodology determination which enables the creation of ACCUs for measures introduced at a facility that reduce the facility's greenhouse gas emissions as against a baseline (where both actual and baseline emissions are measured using data reported under the National Greenhouse and Energy Reporting Scheme).⁵⁹

Safeguard mechanism

In its White Paper, the Government foreshadowed that it would consult on the development of an 'emissions safeguard mechanism' for introduction on 1 July 2015. The purpose of this mechanism was described as being to ensure that emissions reductions paid for through the ERF are not displaced by a significant rise in emissions elsewhere in the economy. As set out in the White Paper, the safeguard mechanism is to apply to direct emissions from facilities which emit 100ktCO₂-epa or more of direct emissions, and is to operate where the relevant 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. However, the White Paper did not specify either the consequences of exceeding the baseline or how new investments or significant expansions would be accommodated.

Following amendments made in the Senate, the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGERA) now provides for the establishment of a safeguard mechanism with effect from 1 July 2016.⁶⁰ Under this mechanism, an entity that has operational control over a designated large facility (a 'responsible emitter') will be required to pay a civil penalty where the direct (scope 1) emissions from that facility exceed a baseline level of emissions.⁶¹ The period in respect of which this assessment is made may be either a financial year or, if determined by the Regulator in accordance with rules made by the Minister ('safeguard rules'), two or more consecutive financial years.⁶² This latter option will potentially allow emissions to be averaged over a number of years, eg so as to address spikes in emissions cycles. The amount of the civil penalty for exceeding the emissions baseline will be prescribed by regulations that are to be made before 1 October 2015⁶³ and will be enforceable through court action by the Regulator. The safeguard rules will specify both the level of direct emissions that will result in a facility being characterised as a designated large facility⁶⁴ and the manner for establishing facility baselines,⁶⁵ and are intended to be made by 1 October 2015.⁶⁶ In order to implement this scheme, responsible emitters will be required to register with the Regulator and to report the relevant facility's emissions for a financial year to the Regulator by the following 31 October.⁶⁷ For the purposes of the safeguard mechanism, the concept of operational control has been extended beyond corporations to other persons such as individuals, local councils and trusts.⁶⁸ As a result, to the extent any of these kinds of entities have operational control over a designated large facility, they will be subject to the operation of the safeguard mechanism and the associated reporting requirements.

A responsible emitter will also be able to surrender ACCUs (or such other carbon units as may be specified in the safeguard rules) to offset any above-baseline emissions from the facility, with such surrender being required to be made by the 1 March that follows the assessment period.⁶⁹ Indeed, the Regulator may seek an injunction to actually require a responsible emitter to surrender such number of ACCUs as is required to offset those above-baseline emissions.⁷⁰

As is evident from the above, many of the significant features of the safeguard mechanism are left to be prescribed by the safeguard rules. However, the legislative framework for the mechanism does raise the possibility of a market developing for the purchase of ACCUs to cover the above-baseline emissions of designated large facilities, thereby providing a source of demand for those ACCUs other than the ERF. Whether such a market eventuates will depend upon how rigorously the facility emissions baselines are set; if, as the Government currently appears to intend, the baselines are very generous, then the demand for ACCUs for this purpose will be extremely limited. Nonetheless, there appears to be scope, at least in the future, to impose increasingly stringent emissions baselines which would assist not only in restraining Australia's greenhouse gas emissions but also in fostering demand for ACCUs, and therefore investment in carbon abatement projects. In addition, while the Government currently has no intention of doing so, the ability of the Minister to prescribe other carbon units that may be used to offset above-baseline emissions, provided that those carbon units represent abatement that is able to be used to meet Australia's international climate change targets,⁷¹ leaves open the possibility of above-baseline emitters being able to surrender potentially cheaper international carbon units to meet their emissions obligations. This would be very close to a baseline and credit trading scheme that, dare it be said, has an element of a carbon tax in it.

Other matters

While the statutory provisions set out many of the principal design features of the ERF, much of the detail has been left to legislative rules (including the safeguard rules), Ministerial directions, the auction rules and methodology determinations. There is still a lot of work to be done in developing these instruments. In particular, the complexities associated with the setting of baselines (both for the facility-wide methodology determination and the safeguard mechanism) should not be underestimated.

As part of the quid pro quo for supporting the legislation that establishes the ERF, the Government has agreed with the Palmer United Party to retain the Climate Change Authority so that it can conduct a review into an emissions trading scheme that is consistent with world's best practice and aligned with Australia's key trading partners. However, the Government has made it abundantly clear that it will not support the re-establishment of an emissions trading scheme for Australia, irrespective of the outcome of this review.

Next steps

With the passage of the enabling legislation, there will be a fairly intense period of consultation on the subordinate instruments that are required to underpin the ERF. Interested parties should ensure that they participate in this consultation, particularly to the extent that the content of these instruments may influence their participation in the ERF or their potential liability under the safeguard mechanism.