National Energy Guarantee - the emissions requirement in Australia's carbon policy landscape

In brief

Following the recent release of the National Energy Guarantee High Level Design Document, Partner Jillian Button and Lawyer Dale Straughen consider how the proposed emissions reduction requirement of the Guarantee will interact with Australia's existing emissions reduction policies. This article is part of a series in which Allens examines aspects of the proposed National Energy Guarantee.

Background and summary

The proposed emissions reduction requirement of the National Energy Guarantee (the Guarantee) seeks to lower emissions in the electricity sector in line with Australia's international commitments. In our Client Update: National Energy Guarantee – development of Emissions Requirement, we discussed the design of the emissions requirement as set out in the Energy Security Board's High Level Design Document dated 20 April 2018 (the HLDD). In this Client Update, we discuss how the emissions requirement of the Guarantee (the Emissions Requirement) is expected to interact with existing emissions reduction policies in Australia.

In summary, the key issues are that:

• the 26 per cent target under the Emissions Requirement is considered by some to be insufficient on the basis that the energy sector has the capacity to make a greater contribution towards achieving Australia's national emissions reduction target under the Paris Agreement;
• to an extent, the Emissions Requirement will overlap with the safeguard mechanism of the Emissions Reduction Fund (the Safeguard Mechanism), which is not sector-specific but applies to many energy generators. This regulatory overlap is largely unproblematic; however, there is a minor risk of double counting, particularly where energy generators are creating, or propose to create, Australian Carbon Credit Units (ACCUs); 
• if offsets are allowed under the Guarantee, the size of Australia's domestic carbon market may increase, and the price of ACCUs may increase;
• the Guarantee is proposed to overlap with the tail end of the Large-scale Renewable Energy Target (LRET). The Emissions Requirement will need to be designed to manage circumstances where a generator has unbundled Large-scale Generation Certificates (LGCs) from energy output in offtake arrangements; and
• the HLDD does not propose that the Emissions Requirement be additional to state and territory renewable energy targets (including those supported by Victoria and Queensland's reverse auction schemes and the ACT's feed-in tariff scheme). The states and territories are expected to seek to preserve the additionality of their schemes.

We expect there to be greater clarity on some or all of these issues in the Energy Security Board's final design document, which is due to be released for consultation in July 2018.

Australia's international emissions reduction goals

Australia has set itself targets of reducing emissions to 5 per cent below 2000 levels by 2020, and to 26 to 28 per cent below 2005 levels by 2030. While the Federal Government expects to meet its 2020 target, emissions are forecast to grow by 3.5 per cent above 2020 levels by 2030, with most of this increase attributable to rising emissions in the transport and agriculture sectors.¹

The Federal Government has indicated that its emissions reduction target for the electricity sector is a 26 per cent reduction on 2005 levels by 2030, and the emissions reduction requirements under the Guarantee will be set to achieve this target. However, while electricity generation represents the largest share of any sector in the national greenhouse gas inventory, it only accounts for roughly one third of Australia's total greenhouse gas emissions, leaving significant work to be done elsewhere in the economy for Australia to meet its national emissions reduction target by 2030. Given the greater capacity of the electricity sector to cut emissions as compared with other sectors of the economy, calls have been made for the electricity sector to take responsibility for more than its proportionate share of emissions as part of any national carbon reduction effort.²

The Federal Government has committed to locking in the electricity emissions target under the Guarantee for an initial 10-year period from 2021–2030, and for future targets to be set for five-year periods with at least five years' notice (eg targets for 2030–2035 would be set by 2025). This approach aligns with the five-year review cycle under the Paris Agreement and allows the target to be adjusted in future in line with Australia's international commitments, although the initial 10-year period and required five-year notice period could serve to entrench Australia's existing 2030 targets under the Paris Agreement when they are next due to be updated in 2025.

Interaction with the Safeguard Mechanism and domestic carbon markets

Unless and until the Emissions Requirement is introduced, the Safeguard Mechanism will remain Australia's primary regulatory tool for managing the emissions of large greenhouse gas emitters. In the absence of indications to the contrary, by default the Federal Government's policy appears to keep the Safeguard Mechanism in operation after the commencement of the Guarantee.

The Safeguard Mechanism is not sector specific, but the 200 or so facilities it applies to are largely in the energy, resources and industrial sectors. The introduction of the Emissions Requirement will result in regulatory overlap in the energy sector, albeit the Safeguard Mechanism will apply at the generation stage, and the Guarantee will apply at the retailer / large-user stage.

Overall, we do not expect this to be problematic, noting that the Safeguard Mechanism is directed at arresting emission increases in the energy sector, and the Emissions Requirement is directed at driving emissions down. Furthermore, there is still work for the Safeguard Mechanism to do, noting that the Guarantee applies at a portfolio level, and the Safeguard Mechanism applies at a facility level.

A generator who over-performs under the Safeguard Mechanism is not able to sell its excess credits, so there should not be any double counting of emissions reductions by generators.

It also would make sense for the Guarantee to be designed so as to recognise any offsets acquired and acquitted by a generator who exceeds its baseline under the Safeguard Mechanism. To do otherwise would result in a double penalty for the same excess emissions.

However, a challenge exists for the Guarantee's designers to ensure that, where a liable entity under the Safeguard Mechanism proposes to utilise ACCUs created in connection with an energy generation facility (eg under the Facilities, Coal Mine Waste Gas, Oil and Gas Fugitives, Alternative Waste Treatment or Landfill Gas methodologies under the Carbon Farming Initiative), the emissions reductions associated with those activities are not double counted under the Guarantee via the customer who offtakes energy from that facility. The same principle applies in relation to ACCUs traded on the voluntary market (which in Australia is currently larger than the mandatory market).

Entities proposing to enter into arrangements involving energy sector ACCUs should also consider their position in the event that the introduction of the Guarantee results in the revocation of approved methodologies under the Carbon Farming Initiative.

Another consideration for mandatory and voluntary ACCU market participants is that the HLDD contemplates the use of ACCUs to offset excess emissions under the Guarantee. The size of Australia's mandatory carbon market could expand significantly if this occurs, and increased demand may push up the domestic carbon price, which by international standards are low in Australia at present. 

Interaction with the LRET

The HLDD indicates that the Emissions Requirement will co-exist with the LRET until the LRET scheme finishes in 2030. Importantly, participation in the LRET will not preclude generation from contributing to a retailer's emissions reductions for the purposes of the Guarantee, and some overlap between the two schemes can be expected.

Under the Emissions Requirement, retailers would obtain the rights to generation and associated emissions under contract, and submit to an emissions registry the volume of output from generators to which they have obtained rights (eg 'X MWh from Y generator'). These submissions would be verified by the relevant generators to ensure validity.

Parties would be free to agree terms they see fit to ensure that the retailer obtains the rights to the generation and associated emissions. An offtake agreement under which a retailer receives generation and LGCs from a generator registered under the LRET scheme could presumably be used to demonstrate that a retailer has obtained the rights to assign generation and associated emissions for the purposes of the Emissions Requirement. However, this type of contract is likely to be the exception and the situation is less clear in circumstances where renewable generation is separated from its associated LGCs, or where contracts do not specify the sources of generation, and this may require further agreement to allocate rights to determine which party obtains the rights to generation and associated emissions for the purposes of the Emissions Requirement.

The HLDD also recommends that the LRET continue unchanged following the introduction of the Emissions Requirement and that it continue to be open to new entrants up to 2030. Given the LRET is expected to meet its target of 33,000 GWh of renewable energy annually by 2020 ahead of schedule, these new participants will add to an already oversupplied LGCs compliance market and place downward pressure on LGC prices. If the market anticipates an imminent decrease in the spot LGC prices, electricity retailers looking to manage their liability under the LRET scheme may seek to carry forward part of their liability to later years when prices are lower. As the spot LGC price continues to decline in the period between 2020 and 2030, holders of surplus LGCs may look to find further value for these LGCs via sale in the voluntary market.

Interaction with state and territory policies and voluntary schemes

The Federal Government has announced that state or territory RETs will not alter the emissions reduction target under the Guarantee (ie they would not be additional to the Emissions Requirement). In particular, generators receiving subsidies through state or territory emissions reduction or renewable energy targets would be permitted to count that generation towards meeting their obligations under the Emissions Requirement.

If adopted, this design could undermine the ability of state and territory governments to reduce emissions by increasing the share of renewable energy generation in their jurisdictions, as new zero-emission generation could be used by retailers to bring down their emissions intensity for the purposes of the Guarantee, effectively double counting the emissions reduction already accounted for under state or territory RETs.

The opposite approach has been taken regarding voluntary emissions reduction schemes such as GreenPower. For these schemes, retailers' emissions reduction obligations will be adjusted to factor in the generation they have received through voluntary emissions reduction schemes, meaning those retailers will be required to meet additional obligations above those otherwise set by the Guarantee. This adjustment should protect the additional emissions reductions offered by voluntary schemes.
State and territory governments are expected to seek to preserve the additionality of their RET schemes. This could be achieved by excluding zero-emissions energy subsidised under state and territory RETs from the calculation of emissions intensity for Emissions Requirement purposes as is proposed for emissions from voluntary schemes. It remains to be seen whether the Federal Government will agree to this.

Conclusion

The Energy Security Board is due to release the final design documentation for the Guarantee for final consultation in July 2018. Noting that a recommendation is proposed to be put to the COAG Energy Council for approval in August 2018, it seems unlikely that further large-scale changes will occur after the July paper is released. At that point, further clarity as to key interactions with elements of Australia's carbon policy landscape may be available.