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Focus: Now for the Direct Action Plan

9 September 2013

In brief: The Coalition's election victory means that, assuming it ultimately gains control of the Senate, or is otherwise able to garner sufficient votes from the non-Coalition parties in the Senate, the current carbon pricing scheme will soon be replaced with the Coalition's Direct Action Plan. Partner Grant Anderson reports.

How does it affect you?

  • The carbon pricing scheme is highly likely to be repealed and replaced with the Coalition's Direct Action Plan.
  • This may result in the need for some contracting parties to address transitional issues, but this should not be a major problem.
  • The Government will now need to develop the detailed arrangements required to underpin its Direct Action Plan, including the funding criteria and how the competing needs of investment certainty and guaranteed emissions reductions are to be addressed.
  • It is not clear that the Direct Action Plan will be sufficient to drive significant investment in emissions abatement, including the abatement that is necessary for Australia to reduce its emissions by five per cent of year 2000 levels by 2020.
  • The ACCC will be charged with ensuring that businesses back out any carbon-related cost components from their prices. 

Repeal of the carbon pricing scheme

The new Government has stated that the repeal of the existing carbon pricing scheme will be its 'first legislative priority', with the necessary legislation being introduced on the first day of the next Parliamentary session.

Because carbon pricing scheme liabilities during the fixed price phase are acquitted by the simultaneous purchase and surrender of carbon units that are acquired from the Clean Energy Regulator, it will be relatively simple to terminate the scheme without adverse consequences for liable entities. This is because liable entities will not be in a position of holding carbon units, for which they have paid valuable consideration, that are subsequently rendered valueless due to the repeal of the scheme. Similarly, the recipients of carbon units under the Jobs and Competitiveness Program or the coal-fired electricity generation assistance program will generally not be disadvantaged by the repeal of the scheme. Those carbon units have been provided to them for free to meet scheme liabilities that will no longer exist or to pay for carbon tax-induced increases in electricity prices that should no longer include a carbon component. That is not to say that there may not be some transitional issues. For example, a number of parties have entered into agreements for the forward sale and/or repurchase of such free carbon units, as well as carbon pass through agreements that entail the transfer of their free carbon units in lieu of increased electricity prices. It is possible that the termination of the scheme will result in financial or timing mismatches under these agreements that will need to be considered.

The repeal of the carbon pricing scheme will also affect the price at which Kyoto-compliant Australian carbon credit units generated under the Carbon Farming Initiative are able to be sold. The removal of the mandatory source of demand represented by the carbon pricing scheme is likely to adversely affect the future revenue streams that would otherwise have underpinned those projects, and it is unlikely that the voluntary market will provide comparable prices. Having said this, when the scheme would have entered its floating price phase (on 1 July 2015), there would have been a substantial reduction in the carbon price in any event.

The Direct Action Plan

With the demise of the carbon pricing scheme, the Coalition's Direct Action Plan will now be the focus of Australia's emission reduction efforts, and it is therefore incumbent on the Government to lay out the details of how it proposes to implement that plan. The lynchpin of the Direct Action Plan is a $1.55 billion1 Emissions Reduction Fund, which is to be used to purchase emissions abatement.

In order to ensure that this money is spent cost-effectively on real emissions reductions, it will be necessary to specify clearly the criteria that are to be applied in determining which projects to fund. Importantly, this funding criteria should include:

  • robust additionality requirements to ensure that the projects that are being funded would not have been commercially viable (and therefore not otherwise undertaken) without backing from the Fund; and
  • robust baseline-setting methodologies against which emissions reductions can be measured – the current suggested 'business-as-usual' emissions baseline is unlikely to provide this, given that whole of business emissions may be affected by production levels (which are in turn affected by economic conditions) and corporate restructurings, and so reductions below that baseline will not necessarily represent improvements in emissions efficiency.

It will also be important for the auction process that is being used to procure the emissions reductions to manage the trade off between investment certainty and guaranteed emissions reduction outcomes. If a project is to be truly 'additional', then investors are unlikely to be willing to proceed with it unless they are certain of obtaining funding. They will therefore wish to pitch proposed projects to the Fund. Conversely, the Government will wish to ensure that the funds provided produce guaranteed emissions reductions, which will only be the case if the selected projects are already in operation (ie where development and output risk have largely been addressed). In addition, investment certainty means that the Fund will need to commit to long term emissions reduction offtake agreements. A spot auction for realised emissions reductions will not suffice. This in turn raises difficult issues of:

  • comparing a range of projects with different durations and risk profiles;
  • ensuring that funds are available over the life of the Fund and not merely fully allocated up-front to earlier projects, with proven technologies, which might not ultimately be the cheapest projects; and
  • putting in place security structures that address both technical risks (eg if the emissions reductions attributable to a sequestration project were to be reversed by natural disaster or land-use change) and financial risk (eg if the project were to become insolvent).

However, perhaps an even more fundamental issue from an investment perspective is the absence of a mandatory market for emissions abatement. In the absence of the carbon pricing scheme, there will be no deep pool of demand for those emissions reductions that are derived from the project and not purchased by the Fund. Instead, such emissions reductions will need to be sold on the voluntary market, which is characterised by low prices and corporate social responsibility buyers. The lack of an assured revenue stream, in addition to that provided by the Fund, may well deter investment in emissions abatement projects in the first place.

Quite apart from these matters, there is the issue of whether the Fund will elicit emissions abatement that is sufficient to enable Australia to meet its minimum commitment of a five per cent reduction on year 2000-level emissions by 2020. The Government has stated that it will not increase its funding for emissions abatement beyond what it has already announced (see above); yet, serious doubts have been raised as to whether the Fund will be sufficient to enable this commitment to be met, at least from domestic projects alone2. Moreover, in the absence of an emissions cap (and associated penalties for emissions above the cap), there is no incentive to reduce total emissions, which means that any emissions abatement bought by the Fund could be offset (and exceeded) by increasing emissions from other operations.

Carbon surcharges

The Government has promised to complement the abolition of the carbon pricing scheme with the establishment of a special unit within the Australian Competition and Consumer Commission that will be tasked with ensuring that prices are reduced commensurate with the reduction in carbon costs.  In addition, the Competition and Consumer Act 2010 (Cth) is to be amended so as to prohibit carbon-cost related surcharges. This will be an area that businesses will need to monitor carefully, particularly where they have included indirectly incurred carbon costs (ie. those passed on to them by upstream suppliers) in their pricing. The clear indication is that the Government expects to see a reduction in prices as a result of the abolition of the carbon pricing scheme, and so businesses that have attributed previous price increases to the carbon pricing scheme will need to look at how to identify and remove the associated carbon costs from their price structure, failing which they are likely to be subject to regulatory scrutiny.

Consistently with this, the Government proposes to direct the Australian Energy Regulator to review existing electricity and gas transmission and distribution determinations, so as to remove any carbon allowances made in those determinations. In fact, this is more likely to be an issue for State regulator-determined retail prices where the carbon component is embedded in the calculation of the regulated prices, rather than being able to be passed through as a separately identifiable surcharge (that does not apply if there is no carbon impost). Having said this, it is the case that demand forecasts that underpin regulated transmission and distribution charges will have taken into account the demand-suppressing effects of the carbon pricing scheme. However, the Government is presumably not intending that regulators revise these forecasts upwards, as this will only increase network charges!

Footnotes
  1. Over the forward estimates period.
  2. The Age, 'Modelling finds $4b hole in Coalition climate policy', 15 August 2013. 

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