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Focus: Who will be liable under the carbon pricing scheme?

3 August 2011

In brief: The Federal Government has released exposure draft legislation to establish its proposed carbon pricing scheme. Partner Grant Anderson identifies the entities that will be directly liable under the scheme and outlines some of the issues to be considered in structuring a corporate group's carbon liability.

How does it affect you?

  • An entity will be liable under the carbon pricing scheme where it has operational control over a facility that emits 25ktCO2-epa or more of greenhouse gas emissions in the stationary energy, industrial processes or waste sectors or by way of fugitive emissions in the resources sector. However, the entity may be able to transfer that liability either to another member of its corporate group or to an entity outside its corporate group that has financial control over that facility.
  • Operators of unincorporated joint ventures that have operational control over such a 'covered' facility may also be able to transfer their carbon liability in relation to the facility to the joint venturers in proportion to their respective shares of the economic benefits of the facility. However, this will not be possible where the operator is also a joint venture participant or any of the joint venturers is a foreign person.
  • Where the participants in an unincorporated joint venture collectively have operational control over a covered facility, they will need to notify the Clean Energy Regulator and the carbon liability in relation to the facility will be borne by each of them in proportion to their joint venture interests. However, if one of the joint venturers has operational control over the facility to the exclusion of the others then it will bear all of the carbon liability.
  • Partnerships do not have the benefit of the provisions that apply to unincorporated joint ventures which means that the operator of a partnership's covered facility will not be able to transfer the carbon liability to the partners and, where the partners collectively have operational control over the covered facility, they will need to nominate one of their number to take on the entire carbon liability associated with the facility.
  • Natural gas retailers (and, in certain circumstances, the operators of small facilities that combust natural gas) will be liable for the greenhouse gas emissions embodied in the natural gas that they supply (or use). However, natural gas retailers may be able to transfer that liability to large customers who choose to purchase that gas under an obligation transfer number. In such a case the gas should be sold at a carbon-exclusive price.
  • The structuring of a corporate group's carbon liability may be a complicated process, and also needs to take into account the ability of members of the corporate group to access contractual cost pass-through clauses.
  • Corporate groups will need to look again at their national greenhouse and energy reporting arrangements, as the carbon pricing scheme will require additional reporting by different corporate group members. In addition, the greenhouse gas emissions reported under the national greenhouse and energy reporting scheme will include both covered and uncovered emissions, whereas reporting for the purposes of the carbon pricing scheme is limited to covered emissions.

Background

The features of the carbon pricing scheme that are set out in the Federal Government's exposure draft legislation are largely consistent with those set out in its previously released policy, Securing a clean energy future: The Australian Government's climate change plan. The package of draft legislation comprises a number of Bills but the key Bills are the Clean Energy Bill 2011 (Cth) (the CEB), which establishes the carbon pricing scheme, and the Clean Energy (Consequential Amendments) Bill 2011 (Cth) (the CECAB), which makes a number of significant amendments to the scheme for reporting greenhouse gas emissions, energy production and energy consumption, that is set up under the National Greenhouse and Energy Reporting Act 2007 (Cth) (the NGERA).

Having said this, there is still a significant amount of detail that has yet to be provided in the form of legislation to establish the household assistance package and the $300 million assistance package for the steel industry, and regulations to underpin the operation of the carbon pricing scheme. In particular, as with the previously proposed Carbon Pollution Reduction Scheme (CPRS), the assistance arrangements for emissions-intensive trade-exposed industries (the Jobs and Competitiveness Program) will be established by regulations, and none of the fundamental architecture for these arrangements (such as the assistance rates, the eligibility criteria for assistance, the supplementary allocation of free carbon units for LNG, and the requirement that changes to these arrangements that are adverse to assistance recipients cannot be made until 1 July 2017 – and then only on three years' notice1) are enshrined in legislation2. The Federal Government has indicated that it will release draft regulations for this purpose at some stage before Parliament votes on the CEB. In addition, there are a number of measures (including the initial $1 billion of cash to be provided to coal-fired electricity generators for 2012-13, the $1.3 billion assistance arrangements for gassy coal mines, the arrangements for the buy-out of 2,000MW of highly emissions-intensive coal-fired electricity generation capacity, and the clean technology funding schemes) that can be established without legislation or regulations and that will simply be funded as part of the budget process and regulated under administrative guidelines. However, in the absence of these schemes being enshrined in legislation, their funding over successive years is not necessarily guaranteed.

The purpose here is to identify the entities that will be directly liable under the carbon pricing scheme – that is, the entities that will be required to acquire and surrender emissions permits (referred to as 'carbon units') to cover the greenhouse gas emissions that are attributed to their activities. While such liability will only attach to a relatively small number of entities, the consequences of that liability being imposed will be significant for the rest of the economy because it will result in increases in the cost of emissions-intensive and energy-intensive goods and services, such as electricity, gas, aluminium, steel, cement, glass and paper. This article also outlines some of the issues that need to be considered by directly liable entities in structuring their carbon liability using the available statutory liability transfer mechanisms. While it does not consider the contractual options available for allocating the costs associated with an entity's carbon liability, these contractual options will also need to be taken into account in structuring an entity's carbon liability.

The attached table describes the entities that will be directly liable under the carbon pricing scheme and the criteria for liability. It should be noted that liable entities are not limited to corporations, but extend to (among others) trusts, state governments (including their departments and authorities), state-owned businesses and local councils. Broadly speaking, there are two categories of liable entities:

  • entities that are liable for direct greenhouse gas emissions; and
  • entities that are liable for the potential greenhouse gas emissions embodied in natural gas that is supplied or used by them.

Liable entities – direct emissions

The first category of liable entities is those that have operational control over facilities (ie activities) that emit 25ktCO2-epa or more of greenhouse gas emissions that are covered by the carbon pricing scheme (ie emissions in the stationary energy, industrial processes and waste sectors, and fugitive emissions in the resources sector). Land sector-based emissions are excluded from coverage. Emissions from transport fuels, as well as certain synthetic greenhouse gas emissions, are also excluded from the scheme but will have a shadow carbon price imposed on them through changes to applicable fuel tax credits, excise duties, manufacturing levies and import levies.

Liability for the covered emissions of such facilities is imposed on the entity that has 'operational control' over the facility, ie the authority to introduce or implement operating, health and safety, or environmental policies for the facility. Where more than one entity is involved in the ownership or operation of the facility, it is the entity that has the greatest authority to introduce and implement operating and environmental policies for the facility that will be taken to have operational control, and therefore to have liability for the emissions of the facility. Determining which entity has operational control over a facility often entails a degree of judgment – yet the consequences of this determination are significant.

While the entity that has operational control over the emitting facility will have the initial carbon liability, it is possible to restructure that liability by transferring it to:

  • a member of the same corporate group; or
  • a person outside the corporate group who has 'financial control' over the facility.

This transfer is effected by the Clean Energy Regulator issuing a 'liability transfer certificate' in respect of the facility, which it can only do with the agreement of both the liability transferor and the liability transferee. In such a case, the liability transferor, or the liability transferee's ultimate Australian holding company, as the case may be, gives a statutory guarantee that the liability transferee will pay any unit shortfall charge (and associated late payment penalty) arising in respect of the facility's emissions.

One of the improvements that the carbon pricing scheme has made over the CPRS is in the treatment of the facilities of unincorporated joint ventures. Under the CEB:

  • Where the joint venture is managed by an operator who has liability for the facility's emissions (because it has operational control over the facility), that liability can be transferred to the joint venturers in proportion to their joint venture interests with the agreement of the operator and the joint venturers and the approval of the Clean Energy Regulator. Such a joint venture is referred to as a 'voluntary designated joint venture'.
  • Where the joint venturers (as opposed to any operator) collectively have operational control over the facility, liability for the facility's emissions is imposed directly on the joint venturers in proportion to their joint venture interests. Such a joint venture is referred to as a 'mandatory designated joint venture'.

Despite these improvements, there are some limitations and issues relating to them that need to be borne in mind:

  • A joint venture cannot be approved as a voluntary designated joint venture if the operator is a joint venture participant or one of the joint venturers is a foreign person. In such a case, the operator will retain the carbon liability and will need to rely on contractual arrangements to be reimbursed for, or indemnified against, the associated costs by the joint venturers.
  • Where a joint venture is a voluntary designated joint venture, the operator gives a statutory guarantee that the joint venturers will pay any unit shortfall charge (and associated late payment penalty) in respect of the facility's emissions.
  • The participants in a mandatory designated joint venture must notify the Clean Energy Regulator of the existence of the joint venture, failing which they will be liable to a monetary penalty.
  • In the case of both voluntary and mandatory designated joint ventures, the Clean Energy Regulator will make a determination as to the joint venturers' percentage interests in the facility, which will determine their share of the facility's carbon liability. These percentage interests are intended to represent the joint venturers' respective shares of the economic benefits of the facility and so replacement determinations will need to be sought where joint venture interests change or are transferred. It is also not entirely clear how a joint venturer's liability will be calculated where its joint venture interests change over the compliance year.
  • Where one joint venturer has operational control over the facility (eg because it has sufficient voting power to unilaterally introduce and implement operating and environmental policies for the facility), the facility's carbon liability will rest with that joint venturer and that joint venturer will need to rely on contractual arrangements with the other joint venturers to be reimbursed for, or indemnified against, the other joint venturers' shares of the associated costs.
  • Partnerships are not treated in the same way as unincorporated joint ventures. Where operational control over a partnership's emitting facility is with an operator, the operator cannot transfer that liability to the partners in proportion to their partnership interests.3 Where operational control rests collectively with the partners, the partners must nominate one of their number to bear all of the carbon liability for the facility. In these cases, the liable entity will need to enter into contractual arrangements with the (other) partners for it to be reimbursed for, or indemnified against, the costs associated with the (other) partners' shares of that liability.

Liable entities – embodied emissions

The carbon pricing scheme also imposes liability for the potential greenhouse gas emissions embodied in natural gas in some circumstances. Most relevantly, this liability is imposed on natural gas retailers who supply natural gas that is withdrawn from a distribution pipeline, and it accrues when that gas is supplied to another person.4

However, it is possible to restructure this liability by transferring it under an obligation transfer number ('OTN') to a person (a 'large customer') who has operational control over a facility where the facility's covered emissions that are attributable to natural gas combustion are not less than 25ktCO2-epa. While the use of an OTN will generally require the agreement of both the retailer and the large customer, such customers will be able to purchase gas as of right under an OTN where the applicable natural gas supply contract is in existence when the CEB comes into operation. Purchasers of natural gas for use as a feedstock or for the manufacture of LPG, LNG or CNG will also be able to purchase that gas under an OTN, thereby ensuring that it does not attract liability under the carbon pricing scheme.

Where natural gas used for combustion is purchased under an OTN, the price for the gas should be carbon-exclusive. However, retailers and customers will need to monitor the status of a customer's OTN as it is possible for the OTN to be withdrawn or cancelled during the term of the gas supply contract. Moreover, certain administrative requirements attach to the use of an OTN: OTN holders and natural gas retailers are required to notify changes in their details to the Clean Energy Regulator, and natural gas retailers will need to ensure that, where they supply gas under an OTN, the OTN is recorded in the OTN Register as the customer's OTN. In either case a failure to comply with these requirements will attract a monetary penalty.

National Greenhouse and Energy Reporting scheme

As a result of the carbon pricing scheme, companies will need to carefully re-assess their compliance with the National Greenhouse and Energy Reporting (NGER) scheme. For example, under the NGER scheme a company can report the aggregate greenhouse gas emissions from the operation of a series of its facilities that constitute a vertically integrated production process. Under the carbon pricing scheme those emissions will have to be separately reported for each facility where they exceed the emissions liability threshold.

There will also be a much larger range of entities required to report under the NGER scheme. Reporting will no longer be confined to the ultimate Australian holding company of a group that has operational control over facilities where the greenhouse gas emissions, energy production or energy consumption of those facilities which exceed a corporate or facility level reporting threshold. Instead, new reporting entities will include:

  • the subsidiaries of a group who have operational control over emitting facilities that attract liability under the carbon pricing scheme – such subsidiaries will be required to separately report the relevant facility's covered greenhouse gas emissions (although the controlling corporation and the subsidiary could also agree that the subsidiary is to report the greenhouse gas emissions,5 energy production and energy consumption of the relevant facility);
  • participants in an unincorporated joint venture who have imposed on them, or voluntarily assume, carbon liability for a facility of the joint venture that attracts liability under the carbon pricing scheme – such participants will be required to report their proportionate share of the facility's covered greenhouse gas emissions, but it appears that responsibility for reporting the greenhouse gas emissions, energy production and energy consumption of the facility will remain with the operator (in the case of a voluntary designated joint venture) or the joint venturer who is nominated for that purpose by the other joint venturers (in the case of a mandatory designated joint venture);6
  • liability transfer certificate holders – where the liability transfer certificate is held by an entity that has financial control over the facility, that holder will be responsible for reporting not just the relevant facility's covered emissions but also the uncovered greenhouse gas emissions, energy production and energy consumption of the facility; and
  • natural gas retailers, the purchasers of natural gas under an obligation transfer number and (in some circumstances) small facilities that combust natural gas.

Next steps

Submissions on the exposure draft legislation are due by 22 August 2011, and the Federal Government intends to introduce the legislation into Parliament shortly thereafter. If you would like any assistance in drafting submissions, or the advice in relation to the proposed legislation, please contact one of the people below.

Footnotes
  1. However, such notice will not be required where the changes are required for compliance with Australia's international trade obligations.
  2. The Government has provided a considerable amount of detail as to the proposed content of these regulations in its policy document, Securing a clean energy future: The Australian Government's climate change plan, the explanatory material accompanying the CEB and previously released explanatory papers.
  3. While the operator may be able to transfer that liability to one partner (as an entity that has financial control over the facility) that is not the same as transferring proportionate liability to each partner.
  4. Small facilities that combust natural gas supplied by other means will also be liable for the potential greenhouse gas emissions embodied in the gas, with this liability accruing on combustion.
  5. These will include both covered and uncovered emissions.
  6. A failure to nominate a joint venturer for this purpose will result in all the joint venturers being exposed to a monetary penalty and required to individually report the facility's entire greenhouse gas emissions, energy production and energy consumption.

For further information, please contact:

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