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Focus: Climate Change – July 2008Detailed analysis of Green Paper on emissions trading scheme designIn brief:
Following on from our
summary
of the Federal Government's Green Paper on its proposed Carbon
Pollution Reduction Scheme released on 16 July 2008, Partner Grant Anderson
BackgroundOn 16 July 2008, the Federal Government released a Green Paper on its proposals for an Australian emissions trading scheme, to be known as the Australian Carbon Pollution Reduction Scheme (the Scheme). This Scheme, which is intended to commence in 2010, takes into account a range of inputs, including the recommendations of the National Emissions Trading Taskforce, the previous Prime Minister's Task Group on Emissions Trading, the discussion paper on the design of an Australian emissions trading scheme released by the Garnaut Climate Change Review (the Garnaut Review) in March 2008, and the Garnaut Review's recent draft report. It has also been informed by consulatations with various stakeholders and their representative bodies. The Green Paper sets out the Federal Government's preferred position on a number of the design parameters of the Scheme, and identifies those to which further consideration needs to be given. The final design of the Scheme is intended to be settled by March 2009 when the implementing legislation is due to be introduced into Parliament. The preliminary design of the Scheme, as set out in the Green Paper, will be modified and supplemented following the release of the Garnaut Review's supplementary report in August 2008, the Garnaut Review's final report in September 2008, and Federal Treasury's modelling of the economic impact of the Scheme, which is expected to be released in October 2008. The delayed release of this modelling is unfortunate because the forecast economic impact of the Scheme is likely to be an important consideration in the assessment by stakeholders of the Green Paper proposals. The Federal Government's final Scheme design will also take account of submissions made on the Green Paper, as well as submissions made on the Federal Government's exposure draft legislation and the associated White Paper (which are scheduled for release in December 2008). Even then, much of the detail of the Scheme (eg the list of trade-exposed emissions-intensive activities that qualify for assistance, the rates of that assistance and the applicable assistance allocation baselines) will be included in regulations, which will be consulted on during 2009. In addition, the Federal Government may have to modify some aspects of the Scheme as it negotiates the passage of the implementing legislation through Parliament. This is because it does not control the Senate but instead needs to rely on the support of either the Liberal/National parties or both the Greens and two independent Senators.
Unit of tradeBeing a cap and trade scheme, the Carbon Pollution Reduction Scheme operates by requiring greenhouse gas emitters to obtain and surrender (or acquit) such number of carbon pollution permits as is necessary to cover their greenhouse gas emissions during a year. By imposing an emissions cap for each year, and only issuing permits up to that cap, it is possible to control the total quantity of emissions that may be produced in any year. Provided that the cap is below business-as-usual emissions, the permits will have a value that is determined by market forces – that is, as a result of compliance buyers competing with each other to acquire the permits that they require. This value is the carbon price. Emitters then have to decide whether it is more cost-effective to pay the carbon price and continue emitting at their current emissions levels or to abate their emissions (eg by investing in low emissions technology). Progressively reducing the emissions cap over time should result in a higher carbon price, increased investment in low-emissions alternatives and a reduction in total emissions. Under the Federal Government's proposals, these carbon pollution permits will be known as Australian emissions units (AEUs), with one AEU equating to 1tCO2-e. An AEU will be a fully tradeable form of personal property, rather than merely a licence, so that compensation would be payable if the Federal Government sought to extinguish or appropriate it. While each unit would be vintage-stamped, it would have no expiry date. Legal title to an AEU would be recorded in a national registry. While there is nothing to preclude security or an equitable interest being granted over or created in an AEU, an issue will be how third parties can be put on notice about the existence of such a pre-existing right. Apart from those AEUs that are allocated to certain industry sectors for free by way of (transitional) adjustment assistance, AEUs will be sold at auctions that are open not only to compliance buyers and their intermediaries but also to traders (with the only qualification for participation being the provision of a security deposit). The first auction of AEUs is to be held in 2010, before the start of the Scheme. Subject to transitional arrangements, it is proposed that AEUs with a current year vintage will be auctioned (using an ascending clock auction method) at quarterly auctions held during that year, with a fifth auction being held after the end of each compliance year and before the acquittal date. Each year a limited number of AEUs with a future year vintage, extending out to three years, will also be auctioned (using a simultaneous ascending clock auction). These auctions will result in all successful bidders paying a single market-clearing price for the auctioned units. In the early phase of the Scheme, entities that receive free units would also be able to sell those units through these auctions. Once units have been auctioned or (in the case of free units) allocated, they can be traded on the secondary market. This might take the form of either over-the-counter trading or trading on an exchange.
Coverage and liabilityThe Scheme will cover all six Kyoto Protocol gases: carbon dioxide, methane, nitrous oxide and three categories of synthetic greenhouse gases (hydrofluorocarbons, perfluorocarbons and sulphur hexafluoride). It will cover emissions of these gases from the production of stationary energy, industrial processes, waste (eg landfill and sewerage treatment) and transport. The Scheme will also apply to fugitive emissions, such as methane emissions from black coal mining and emissions from flaring during the extraction and processing of oil and gas. However, one of the challenges insofar as fugitive emissions are concerned is to accurately measure them – this is important because, under the Scheme, greenhouse gas emissions will now attract potentially significant financial liabilities. Initially not all industry sectors will be required to purchase all of the AEUs that they require. Some will be allocated free AEUs in order to assist them in transitioning to a carbon-constrained economy. The proposed recipients of this assistance are trade-exposed emissions-intensive industries and industries that (while not trade exposed) are nevertheless likely to be strongly affected by the Scheme. While the Federal Government has determined on a preliminary basis the kinds of industries that are likely to qualify for assistance because they engage in trade-exposed emissions-intensive activities and that, of the non-trade-exposed industries, only coal-fired electricity generation qualifies for assistance as a strongly affected industry, it has called for feedback on whether any other activities might also qualify for assistance on either of these grounds. The application of the Scheme to particular industry sectors is described in more detail below. The Scheme will impose liability on entities in respect of facilities that emit 25,000tCO2-e or more of greenhouse gas per annum (in gross terms), except that as yet to be determined thresholds will apply to emissions in the waste sector. Liability will also be imposed on liquid fuel suppliers and importers to cover the downstream combustion of their petroleum products; on gas retailers, coal producers and the manufacturers of coal-related products to cover the downstream combustion of their products by small users; and on entities that import synthetic greenhouse gases (including in airconditioning and refrigeration equipment). These upstream entities would not be subject to the 25,000tCO2-e pa threshold but might be subject to some kind of threshold that prevents liability being imposed on the smaller entities among them. On this basis, the Federal Government expects that about 1000 companies will incur direct liabilities under the Scheme. More specifically, the Federal Government is proposing that liability to acquire and acquit AEUs will be imposed on the controlling corporation of the group that includes the entity that has 'operational control' over a covered facility or activity (this being a concept that is used for the purposes of the national greenhouse and energy reporting legislation). However, emissions liability will also attach to unincorporated entities that have operational control over covered facilities or activities (eg partnerships, trusts, local councils and government departments). Unincorporated entities are not currently covered by the reporting scheme. Where multiple entities have operational control over a covered facility or activity (as may occur where there is a joint venture), the Federal Government is proposing to require a single responsible entity to register and meet the Scheme obligations. This will raise issues for joint ventures. Under the reporting legislation, a joint venture may nominate one of the joint venturers as a responsible entity for reporting purposes, in which case that entity will be responsible for reporting the total greenhouse gas emissions (and energy consumption and production) of the joint venture as part of its corporate group's inventory. However, this is quite a different proposition from that joint venturer assuming financial responsibility for all of the joint venture's greenhouse gas emissions.
AgricultureAgriculture accounted for 15.6 per cent of Australia's net greenhouse gas emissions in 2006, with its principal non-energy emissions comprising methane from livestock and nitrous oxides from soil (eg because of fertilisers, animal excretion and leaching). While the Federal Government's preferred position is to include non-energy emissions from the agricultural sector in the Scheme, this is not feasible at the outset because of the difficulties associated with measuring these emissions and administering the application of the Scheme to that sector. Instead, the Federal Government will announce in 2013 whether the Scheme will cover the agricultural sector, with any such coverage not to commence until 2015 at the earliest. If agriculture is not covered by the Scheme, then it will be necessary to consider other means of mitigating non-energy emissions from that sector. This does not mean that the agricultural sector will be unaffected by the Scheme. This is because the Scheme will still cover-energy related emissions in the agricultural sector (ie as a result of the combustion of fuel) from the outset, and the Scheme will result in increases in the price of a number of goods and services that are used in that sector (such as electricity, chemicals and fertilisers). A key issue that will need to be addressed if the Scheme is extended to non-energy emissions in the agricultural sector is the point in the production process at which liability to obtain and acquit Australian emissions units to cover those emissions should be imposed. There are more than 100,000 entities in the agricultural sector, most of which are responsible for less than 1000tCO2-e pa of greenhouse gas emissions (well below the 25,000tCO2-e pa threshold for the imposition of direct liability). This means that liability will need to be imposed at a more aggregated level, such as on the food processors (eg abattoirs, dairies and mills) and fertiliser suppliers. Similar issues are currently being debated in New Zealand where non-energy emissions in the agricultural sector are to be covered by the New Zealand emissions trading scheme from 2013. Drawing a distinction between the entity that causes the emissions and the entity that is directly liable for those emissions creates a further challenge – that is, how to encourage the emissions creator to abate those emissions. The Federal Government has, therefore, flagged that it will be looking at ways to encourage agricultural producers to adopt low-emissions management practices (eg by implementing an accreditation program for low-emissions producers). To the extent that food processors have the liability to account for the emissions associated with the agricultural products that they process, they will have two options:
This suggests the way in which an accreditation program could work. By enabling the food processor to identify low-emissions agricultural producers, the processor would be able to pay a relatively higher price to those producers than to high-emissions agricultural producers, reflecting the lower emissions liability that is imposed on the processor as a result of processing the products of the low-emissions agricultural producers. If the Scheme is extended to the agricultural sector, then it is also likely that substantial parts of that sector will qualify for assistance as trade-exposed emissions-intensive activities (see below). In particular, beef cattle, sheep, dairy cattle and rice are likely to be Category 1 activities that receive the highest level of assistance, and pig farming is likely to be a Category 2 activity that receives a lesser (but still substantial) amount of assistance. Current indications are that around 10 per cent of AEUs would be allocated to the agricultural sector to provide this assistance.
ForestryForestry accounted for 6.9 per cent of Australia's net greenhouse gas emissions in 2006. On the credit side of the greenhouse gas ledger, forests absorb (or 'sequester') carbon dioxide, whereas on the debit side deforestation is taken to contribute to greenhouse gas emissions (although this does not reflect the fact that sequestered carbon dioxide actually continues to be retained in harvested wood). The Federal Government is proposing to allow forest managers to voluntarily 'opt in' to the Scheme and therefore to be able to generate credits as a result of carbon stored in their forests. However, by opting in, forest managers will also become liable for any reduction in that stored carbon. In addition, there are a number of qualifications in relation to this proposal. In particular, the Federal Government's approach to forestry is dictated by the treatment of forestry under the Kyoto Protocol. The reason for this is that, if the Federal Government allows emitters to satisfy their emissions-related obligations under the Scheme by surrendering forestry credits that are not recognised at the international level, then it faces a mismatch that exposes it to a 'gap' in meeting its international obligations. In these circumstances, the Federal Government could either take the risk of this exposure or tighten the emissions caps under the Scheme. However, neither of these options appeals to the Federal Government, not least because they might preclude the Scheme linking with other emissions trading schemes that do not recognise non-Kyoto Protocol sanctioned forestry offsets. Under the Kyoto Protocol:
As a consequence, under the Carbon Pollution Reduction Scheme:
The Federal Government's proposed approach will be of most benefit to post 2008 forests that are not harvested (because they will be increasing their carbon sequestration during the 2008 12 period as they mature), rather than to forests that are mature as at 2008 (which have a stable carbon stock) or plantation forests that are harvested (as harvesting will reduce the carbon stock and expose the forest manager to a potential emissions liability). The Federal Government is still considering the reporting obligations that are to apply to forestry, and these may also impact on the attractiveness to forest managers of opting into the Scheme. An annual reporting and compliance period, which would mean that AEUs would be allocated for net increases in the carbon stock over the reporting year but would also have to be surrendered for net decreases in that stock over that year, would enable the managers of fast-maturing forests to access those units earlier than, say, a five-year reporting and compliance period. Conversely, an annual, rather than a five-year, reporting/compliance period potentially exposes forest managers to a greater emissions liability for that period where the reporting/compliance year is one in which the forest is harvested or destroyed by bushfire. This is because the forest manager will not have sufficient time to replace the forest within that year. It is possible that the Federal Government will allow forest managers to choose between an annual reporting period and a longer reporting period, or even to have a reporting period that is shorter than the compliance period, so they can select that which best suits their circumstances and risk profile. The Kyoto Protocol treats the deliberate removal of forest and its replacement with non-forest land use (ie deforestation) as emitting the carbon dioxide that is stored in the forest. However, the Federal Government is not proposing that deforestation should generate emissions liabilities under the Scheme because of the associated costs and administrative complexity (deforestation occurs on a range of different sized landholdings), Australia's emissions from deforestation have been significantly reduced since 1990, there are legitimate reasons for some deforestation (eg to provide cattle fodder during droughts), and emissions from deforestation are difficult to measure. Instead, the Federal Government proposes that emissions from deforestation should continue to be regulated through more direct measures such as land clearing restrictions. While other forms of biosequestration (eg in croplands and grazing lands) and emissions reductions (eg from avoided deforestation and savanna fire management) will not be recognised under the Scheme, the Federal Government will consult on the generation of offsets from these activities – including the possibility of them being certified for trading in the voluntary market.
Trade-exposed emissions-intensive industriesIt is important that the introduction of the Scheme should not significantly impair Australia's international competitiveness. The Scheme may have this effect where it imposes costs on an industry that is unable to recoup those costs because the industry competes with industries in countries that do not face a carbon price and because the price of its output is a world price (ie the industry is a price taker). These costs may take the form of:
Accordingly, the Federal Government is proposing that up to around 20 per cent of the new Australian emissions units are to be allocated for free to:
The necessary emissions, output and revenue data to determine whether an activity qualifies for assistance and, if so, the category it falls into, is to be determined 'once off' on the basis of historical data (eg for 2006-07 and 2007-08). However, the Federal Government has not yet decided whether the assistance, which is to be based on output, should be based on forecast output (with an end-of-year true up) or on the previous year's output. The allocation of AEUs to these activities will be based on Australian industry-average emissions, rather than the emissions of any particular firm, so as to encourage businesses to undertake emissions-abatement activities, and will be reduced over time at a preset rate that has yet to be determined. These free AEUs are to be provided at the commencement of each compliance year and their provision would be contingent on continued domestic production (ie units allocated above actual production levels for the year an activity ceased would effectively need to be returned to the Federal Government). It is intended that this assistance will cover both direct emissions and indirect electricity emissions that are associated with the covered activity, but not increases in the prices of other sources of energy (eg gas) or of other inputs. If agriculture is subsequently brought into the Scheme, then around 30 per cent of the annual allocation of AEUs will be quarantined for providing assistance to trade-exposed emissions-intensive industries2. The assistance provided to trade-exposed emissions-intensive industries will be reviewed every five years and is to cease if key competitor economies introduce comparable carbon constraints. The Federal Government is specifically seeking further information to assist it in determining the appropriate thresholds for the categorisation of trade-exposed emissions-intensive activities and the allocation of units between those categories, the electricity factor that is to be applied to calculate the increase in electricity costs faced by any such activities as a result of the Scheme, and the rate at which this assistance should be reduced. For these purposes, the Federal Government considers that all industries, other than where there is a physical barrier to trade (eg as is the case with electricity and gas supply and domestic transportation), qualify as trade-exposed. However, without seeking to be either exhaustive or conclusive (and disregarding the agricultural sector), the Federal Government has suggested that Category 1 activities are likely to include aluminium smelting, lime production, cement clinker production, integrated steel manufacturing and silicon smelting, and that Category 2 activities are likely to include ceramic product manufacturing, alumina refining, some non ferrous metal smelting, and some oil and gas (eg LNG3), basic chemicals, non metallic mineral product, and pulp and paper production. On the basis of the thresholds outlined above, activities such as aviation and petroleum refining would not qualify for assistance, and this has already led to protest from these industries.4 Moreover, this assistance will not fully compensate even the covered activities for all of the increased costs likely to result from the Scheme (eg the increased cost of inputs other than electricity and the costs associated with the uncovered portion of their emissions), and will reduce over time. This too has resulted in some industries expressing their discontent with the level of assistance that has been proposed.5 On the other hand, it should be noted that the benchmarks for assistance are based on Australian industry-average standards, rather than world's best practice.
Electricity generation and saleThe Scheme will potentially impose significant liabilities on coal-fired electricity generators. This is because coal-fired electricity generation is emissions-intensive and accounts for around 83 per cent of Australia's electricity generation capacity. Equally, access to cheap and abundant supplies of coal is one of the reasons Australia has enjoyed relatively cheap electricity. Although the Federal Treasury modelling will not be available until October 2008, the Federal Government has suggested that a carbon price of $20/tCO2-e is likely to result in a maximum 16 per cent increase in the average retail electricity prices faced by households. It is important that retail price regulation should not prevent retailers from passing through this increased price to end users (bearing in mind that low-income and middle-income households will receive some compensatory assistance). It is also important to be aware that the indirect impacts on households and businesses of an increase in electricity prices are likely to be significant because electricity is an important input into the production of many goods and services (eg aluminium, iron, steel and glass). In this regard, the Federal Government has estimated, on an indicative basis, that a $20/tCO2-e carbon price could lead to a 0.9 per cent increase in the consumer price index. The Federal Government is proposing to provide some transitional assistance to existing coal fired electricity generators6 through a new Electricity Sector Adjustment Scheme. However, unlike its proposals regarding trade-exposed emissions-intensive industries (see above), the Federal Government's proposals in this area are not very precisely formulated. Instead, the Green Paper simply notes that different delivery mechanisms are likely to be required for the beneficiaries of this scheme (which will include not just coal-fired electricity generators but also workers in the coal-fired electricity generation industry and communities and regions that depend on that industry), and that the Federal Government will be discussing the appropriate form of support with stakeholders. This does leave open the possibility that existing coal-fired generators will receive at least some free Australian emissions units, but the lack of detail at this stage is likely to be of some concern to generators. What the Federal Government has revealed to date is that this assistance will be allocated to exclusively coal-fired generators7 on an asset-by-asset basis in proportion to their capacity as at 3 June 20078 with the Federal Government splitting the total available assistance into separate pools for brown-coal fired and black-coal fired plant. The precise amount of assistance will be determined towards the end of 2008 (after the Federal Government decides on the medium-term national emissions target range that will apply in 2020), taking into account factors such as competing claims for assistance from the Federal Government and any offsetting gains or tax benefits that may be available to the generators. The Federal Government has also indicated that this assistance will be determined on a 'once and for all' basis at the outset of the Scheme (even though it could be delivered over a fixed period of time) and that the assistance will be vetted to ensure that it does not result in windfall gains to any generators. Any assistance that is provided is to be given to the registered generator which, it should be noted, may not be the same as the entity that owns the generation plant (eg as where a registered intermediary has been appointed in respect of the plant). The chapter dealing with the provision of assistance to coal-fired electricity generators is the largest chapter of the Green Paper. Its length, along with the fact that much of the chapter canvasses the difficulties associated with providing such assistance, indicates the degree to which the Government is struggling with this issue. And it is certainly one of the more contentious issues. In its draft report, the Garnaut Review concluded that there was no economic or environmental reason for allocating free emissions permits to coal-fired electricity generators but that such a decision was a purely political one that needed to have regard to the competing claims that would be made for financial assistance because of the introduction of an emissions trading scheme. The provision of this assistance will not, and is not expected to, prevent the price of electricity increasing as a result of the internalisation of the cost of carbon. Instead, the Government has justified its proposal on the basis that the Scheme will result in a significant reduction in the profitability (and therefore asset values) of coal-fired electricity generators. This is because such generators are highly emissions intensive (ie produce well in excess of 1500tCO2-e/$million revenue), compete with less emissions intensive generators (such as gas-fired generators) and so are constrained from passing on a significant portion of their carbon costs, have significant sunk capital costs and (pending the introduction of carbon capture and storage) have few economically viable abatement opportunities. Taking these factors into account, the Federal Government considers that a failure to provide assistance to coal-fired electricity generators9 :
Conversely, the carbon price resulting from the Scheme is likely to make gas-fired baseload generation more competitive with coal-fired generation, even though the price of gas will also increase. This presents substantial opportunities for the gas industry as Australia's baseload electricity generation capacity will need to increase by 8000MW by 2020 to meet expected demand, and each 1000MW of capacity that is gas-fired requires about 70PJ pa of gas. However, the increased demand for gas, and the likelihood that the domestic gas price will in any event rise with the establishment of LNG terminals on the east coast of Australia, will also act to reduce the cost advantage that gas fired electricity would otherwise have over coal-fired electricity. The other beneficiary from coal-fired electricity generation having to pay the carbon price is renewable energy generation. However, a significantly higher carbon price than, say, $20/tCO2-e will be necessary before renewable energy and coal-fired generation are cost competitive. In the meantime, the Federal Government will be depending on its 20 per cent renewable energy target to encourage investment in renewable energy generation (in the early stages mainly wind but possibly expanding, closer to 2020, to encompass solar, tidal and geothermal energy). Unfortunately, this may come at a cost: achieving the target will potentially result in higher-cost, zero-emissions generation technologies displacing lower-cost, low-emissions generation technologies, and therefore increasing electricity prices.
Carbon capture and storageCarbon capture and storage (CCS) will provide a means of reducing the greenhouse gas emissions of coal-fired electricity generation (as well as some other carbon-emitting processes). In the case of CCS, the Federal Government's proposal is:
In other words, CCS operators would not be granted AEUs for geosequestration but will presumably build the saved carbon cost into the price they charge generators for the transport and storage of the captured carbon. Somewhat curiously, given the Garnaut Review's strong recommendation to substantially increase the funding available to CCS projects, the Federal Government has not indicated that it intends to increase its existing commitments in relation to CCS (or, indeed, into the research, development and commercialisation of any low-emissions technologies). This has not gone unnoticed.10
TransportOne of the most politically contentious issues has been whether the Scheme should cover petrol. Although it is now clear that petrol will be included, the Federal Government will reduce the fuel tax on a cent-for-cent basis to offset the initial price impact of the Scheme. This measure will be reviewed after one year in the case of heavy vehicle road users, and after three years for other road users. An equivalent rebate will be provided to businesses in the agricultural and fishing industries, as the excise system effectively does not apply to these industries. One criticism of this approach is that petrol users will not see an emissions liability-induced increase in the petrol price they pay and so will not have any incentive to reduce their petrol consumption (although the recent significant increase in petrol prices may have such an effect if it is sustained11). A further concern is that the favourable treatment accorded to petrol (effectively road transport) discriminates against the rail, aviation and shipping industries, where those industries (and therefore consumers of the services they provide, such as public transport) are required to pay the carbon price.12 In order to include liquid fuels such as petrol (and also diesel, jet fuel and any synthetic fuels13) in the Scheme, it is not feasible to impose the emissions liability on the entities that actually combust those fuels – at least to the extent they are small users. Accordingly, the Federal Government is considering the appropriate upstream point at which such liability should be imposed. Its current proposal is to impose that liability at the point that excise or customs duty is paid – this will capture petroleum refineries, fuel importers, and fuel distributors and blenders (around 200 entities in total).14 In these circumstances it will be necessary to develop an offsetting/credit scheme so as to avoid double counting; for instance, as where petroleum is not combusted but is used to manufacture another product (such as plastic). The Federal Government is not proposing at this stage to allow large fuel users to 'opt in' to the Scheme to manage the emissions-related liabilities that are attributable to their fuel use because this is likely to be complex. However, it will look at developing such an approach after the Scheme has been in operation for one year. Fuel used in international air and marine travel, ie where the destination is overseas even if there are some domestic stops, will not be covered by the Scheme. This had led to some concern that domestic transport will be put at a disadvantage compared to international transport, at least where they compete on domestic legs.15
Gas supplyThe Federal Government has estimated that a carbon price of $20/tCO2-e will result in households paying on average up to 9 per cent more for their natural gas (although this may depend on any applicable retail price caps being lifted to enable this increase to be passed through by retailers to end users. Because it is not feasible to impose direct emissions liability on small natural gas users, the Federal Government is proposing that this liability would be imposed on their natural gas suppliers (ie retailers or producers). However, large natural gas users, being those users who combust natural gas and produce more than 25000tCO2-e pa in emissions, would be directly liable for those emissions. Again, this means that it will be necessary to develop netting-out arrangements, on which the Federal Government is seeking further input.
Annual caps and targetsThe Federal Government is proposing that annual emissions caps generally be set on a rolling five-year basis (or longer if Australia's international commitment period is longer), with gateways being set every five years for the 10-year period beyond the Scheme caps. So, for example, the Federal Government would set initial annual caps for each year in the period 2010-11 to 2014-15, with a gateway (ie a range within which caps for those years may fall) for each of the years from 2015-16 to 2024-2025. The Federal Government will explain the approach that is to be adopted for setting caps for the first five years of the Scheme in its upcoming White Paper. In addition, the White Paper will set out an indicative national emissions trajectory for the 2010-11 to 2012-13 period (ie a trajectory for both the emissions that are covered by the Scheme and those that are not covered). In 2010 this trajectory will be extended to 2014-15, when the Federal Government is able to take account of any progress made in the negotiation of an international climate change agreement, and it will be extended by a year in every subsequent year. In early 2010, the Federal Government will announce the first five years of caps for 2010-11 to 2014-5 and the initial 10 years of gateways for 2015-16 to 2024-25. The White Paper will also set out a medium-term target range (as opposed to a single-point target) for 2020. This range will be set having regard to the Federal Treasury's economic modelling and the recommendations of the Garnaut Review. Given the commitment of the European Union to a 2020 target of reducing 1990-level emissions by 20 per cent (unilaterally) and 30 per cent (if other developed countries follow suit), and that a 25 40 per cent reduction on 1990 levels was canvassed at the Bali conference last year it will be interesting to see the level at which the Federal Government ultimately sets the 2020 target.16 For the longer term, the Federal Government has set a target of reducing greenhouse gas emissions to 40 per cent of their 2000 levels by 2050, although such a target can only be regarded as aspirational at best, given that this timeframe is well beyond the usual political time horizon. Perhaps somewhat surprisingly, the Green Paper proposes that the Federal Government will set out the annual caps in regulations. While this does give some certainty to industry, it also means that Parliament may effectively overturn the Federal Government's settings. However, it has been speculated that the Federal Government will resile from this proposal.17
Transitional measuresThe Garnaut Review's draft report favoured a direct move to an unconstrained carbon price but acknowledged that there was a case for fixing the permit price in the 2010-12 period so as to provide a 'soft start' to emissions trading. In the Green Paper, the Federal Government is proposing a cap on the price for Australian emissions units for the period 2010-11 to 2014-15 so as to limit the costs of the Scheme to business (with the continuation of this cap being reviewed in 2014-15). While seeking input on the form of the price cap (ie whether it should take the form of access to fixed price permits, an administrative penalty or some other mechanism), the Federal Government has stated that the level of the cap should be set high enough to ensure a very low risk of its being exceeded. A consequence of this approach is that there will be no 'make good' obligation (ie an obligation on liable entities to acquire units to cover any deficit at the prevailing market price), although the monetary penalty could be put towards acquiring make-up units. The Green Paper also finally puts to rest the previous Federal Government's proposal for an early action credit scheme preferring to rely instead on the incentive that the Carbon Pollution Reduction Scheme provides to reduce emissions before its commencement so as to reduce the number of AEUs that need to be acquired by liable entities.
Safety valvesIn addition to the price cap, the Federal Government is proposing two 'safety valves' that should assist in smoothing out the potential volatility of the carbon price and easing any substantial upward pressure on it. Banking and borrowing As expected, the Federal Government is proposing to permit unlimited banking of Australian emissions units. However, while it will permit units to be borrowed, it will impose a percentage limit on the quantity of units that a liable entity may borrow (being something less than 5 per cent of the entity's unit surrender obligations), and will limit the units that may be borrowed to those which have a vintage of the year that follows that in respect of which they are surrendered. The Federal Government proposes to publish the annual levels of banking and borrowing under the Scheme. Offsets Because of its extensive sectoral coverage, the Scheme leaves little room for domestic offsets (or joint implementation projects in Australia under the Kyoto Protocol). Even in the case of the one excluded sector, agriculture, the Federal Government is not intending to permit the creation of offsets at this stage because of the reasonably strong likelihood that agriculture will become a covered sector within five years of the Scheme's commencement. Moreover, the recognition of domestic offsets is administratively complex (due to the need to establish baselines) and any acceptable offsets would need to satisfy rigorous tests (eg regarding additionality). For these reasons, the Federal Government is not disposed to consider including domestically generated offsets in the Scheme until 2013.18 The Scheme will, however, be designed so that it can be linked with other international schemes and carbon trading markets, this being consistent with the Federal Government's preference for an open trading scheme in the long term that has an effective global emissions constraint. While the Federal Government's primary motivation in creating international linkages is to support a global climate change solution, international linkages will also ensure that liable entities can access low-cost international pollution reductions to offset their domestic liabilities under the Scheme. Initially, these international offsets will be in the form of certified emission reductions (CERs)19 and emissions reduction units (ERUs), each of which are created under the Kyoto Protocol flexibility mechanisms and result from emissions abatement projects that are undertaken in developing and developed countries respectively. However, the Federal Government recognises that establishing international linkages will not be without risk and so proposes to limit the volume of international credits that a liable entity can surrender for compliance under the Scheme to a maximum percentage of that entity's unit surrender obligations. The size of this limit for the period from 2010-11 to 2012-13 will be included in the White Paper, with the limits for the period from 2013-14 to 2014-15 being announced in 2010 and, thereafter, on a one-year rolling basis. Linking arrangements will be subject to continuing review as international markets develop. The Federal Government has committed to investigate direct bilateral linking opportunities with other countries' schemes as they are established.
ReportingThe Federal Government's national emissions and energy reporting scheme has already begun, with the first reporting year being the current financial year. Like the reporting scheme, the Carbon Pollution Reduction Scheme will operate on a financial year basis so that the annual emissions reports that liable entities are required to submit under the reporting scheme will also meet the reporting requirements under the Carbon Pollution Reduction Scheme. In order to ensure that the data that is submitted is accurate, those who emit more than 125,000tCO2-e pa of greenhouse gases will be required to have their annual emissions reports vetted by an independent accredited third party. The Federal Government will consider extending this requirement to smaller emitters in due course. However, there are a number of changes that will need to be made to the reporting scheme in order to implement the Green Paper proposals, in particular to:
It should also be noted that the Federal Government is considering requiring the publication of:
Other assistance measuresA key component of the Federal Government's proposal is to provide targeted transitional assistance to low-income households20 as a result of the increased costs of goods and services that will result from the introduction of the Scheme. In addition, the Federal Government is proposing to establish a Climate Change Action Fund, which will assist workers, communities and businesses in adjusting to a carbon-constrained economy through funding investment in innovative new low-emissions processes, the development of industrial energy-efficient projects, and the dissemination of energy efficiency information to small- and medium-sized businesses.
Licensing requirementsAs flagged in early June 2008, the Federal Government is proposing to classify Australian emissions units as 'financial products' for the purposes of the Corporations Act 2001 (Cth). The effect of this is that those who trade in these units will need to obtain an Australian financial services licence and (particularly to the extent they trade with retail customers) comply with the disclosure requirements contained in Chapter 7 of the Corporations Act. As the law currently stands, AEUs would not be caught by these provisions and it is only those who trade in financial instruments based on them (eg hedges) who would need to hold an Australian financial services licence. It is important that those who intend to trade in AEUs are aware of this proposal so they can put in place the necessary licensing arrangements.
Tax and accounting issuesChapter 11 of the Green Paper outlines the Federal Government's proposals in relation to the tax and accounting treatment of Australian emissions units. These proposals merit close attention.
The next stepThe Federal Government has called for submissions
on the Green Paper by 10 September 2008, following which it will release a White
Paper and exposure draft legislation in December 2008. If you would like
assistance in drafting your submissions or any other information, please contact
any of the people below.
Footnotes
For further information, please contact:
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