12 September 2008
Key Points:
Companies need to examine the issue of operational control closely as the details of the scheme emerge.
There are a number of possible approaches to assigning responsibility for greenhouse gas emissions under an emissions trading scheme such as the proposed Carbon Pollution Reduction Scheme ("CPRS") - each has different implications for companies operating under such a scheme. In this article we'll examine the implications of the Government's preferred approach, and an alternative approach also discussed in the Green Paper, which offers specific advantages.
In their Greenhouse Gas Protocol initiative, the World Resources Institute and the World Business Council for Sustainable Development identify two broad approaches to assigning responsibility: the "Equity Share approach", in which liability for emissions is assigned according to ownership of the equity in enterprises that generate emissions, and the "Control approach", in which liability is assigned according to who controls the facilities that generate emissions. The Control approach can be divided further into two distinct approaches: assigning liability according to financial control of a facility or enterprise ("Financial Control approach") or the operational control of a facility ("Operational Control approach").
According to the Green Paper, the Government prefers the Operational Control approach. This approach is already embodied in the National Greenhouse and Energy Reporting Act 2007 (Cth) ("NGER Act") for assigning responsibility for measuring and reporting emissions.
The Operational Control approach
Under the Government's preferred approach, the company with "operational control" over a relevant facility is responsible for 100 percent of the greenhouse gas emissions from that facility.
The Greenhouse Gas Protocol, Green Paper and NGER Act use broadly similar definitions of "operational control". Essentially, a company will be defined as having "operational control" where:
In cases where more than one company can provide input into the operational and EHS policies for a facility, the company with the "greatest" authority to introduce and implement such policies is regarded as having "operational control".
The Government states that it has identified this approach as its preference for the following reasons:
However, it is by no means clear that the Operational Control approach will deliver these advantages. While the costs of compliance with emissions reporting requirements might be lower under this approach, the GPRS also has implications for regulatory compliance with financial accounting and corporate disclosure requirements, which fall upon equity owners, rather than the operational controllers, of enterprises. Separating emissions obligations from other compliance requirements may well increase compliance costs for both scheme participants and the Government, and also has the potential to increase, rather than reduce, the administrative complexity of the scheme.
It is also questionable whether operational control does afford the greatest opportunity to reduce emissions. In many cases, emissions reductions may best be achieved by capital expenditure (for example, by installing newer technology), and companies with operational control of a facility may not be in a position to initiate such expenditure.
Given that operational control will depend upon the degree of authority to introduce and implement operational and EHS policies, in circumstances where complex operation and maintenance contracts exist, and multiple companies have input into such policies, determining which company has "operational control" will not be a straightforward task. Companies who are parties to such contracts, whether as contractors or asset owners, should examine the provisions of those agreements to determine their likely impact on where the liability for greenhouse emissions will fall.
The Financial Control approach
Under the Financial Control approach, liability for emissions permits would fall on the entities able to direct the financial and operating policies of a company with a view to gaining the economic benefits of its activities. Financial control may be separate from equity ownership, although in most cases, control of a majority of equity shares in an entity will be accompanied by the capacity to direct its financial and operating policies. The Green Paper considers that the Financial Control approach is likely to result in higher administrative complexity and implementation risks that competing approaches. The approach appears to share some of the issues of Operational Control, while lacking some of its advantages.
An alternative: the Equity Share approach
In contrast to the Operational and Financial Control approaches, under the Equity Share approach, a company would account for emissions from a facility according to its share of equity in the facility. This approach reflects economic interest, which is the extent of rights a company has to the risks and benefits flowing from a facility. Typically the equity share would be the same as the ownership percentage in a facility.
Notwithstanding the Government's preference, the Equity Share approach potentially offers some advantages over the Operational Control approach in terms of administrative simplicity and compliance costs.
For the purpose of assessing risks posed to a company, emissions accounting and reporting based on equity share arguably provides a more representative approach. It provides a realistic picture of liabilities and risks associated with emissions to management, employees, shareholders, and company stakeholders.
Further, the equity share approach ensures consistency with companies' disclosure obligations under the Corporations Act and, in the case of public companies, the ASX Listing Rules.
In addition, future financial accounting standards may treat greenhouse gas emissions as liabilities and emissions allowances or credits as assets. The equity share approach would arguably result in closer alignment between greenhouse gas accounting and financial accounting.
As the Green Paper is an early stage in the development of the CPRS, it is possible that the Government may be swayed in the direction of the Equity Share approach as policy development progresses, however there remains a strong likelihood that the Government's preferred approach will be retained in the final policy.
Accordingly, companies engaged in complex contractual arrangements for the management and operation of facilities which emit greenhouse gases should closely examine their contracts and corporate structures in order to assess the potential impact of the Operational Control approach on their business.
For further information, please contact Brad Wylynko.
