Will investors feel secure with the proposed emissions trading scheme?

By Paul O'Donnell and Felicity Cuthbertson.

Key Points:
The findings of the Task Group may not convince the business community that it provides investment security, with the recommendations including a rolling ten year period for permit allocation and no further clarification on permit prices or possible reduction targets.

Australia could have an emissions trading scheme by 2011, depending on global developments in the area, according to the report released on 1 June 2007 by the Prime Ministerial Task Group on Emissions Trading.

A joint government-business initiative, the Task Group was commissioned by the Government to advise on the possible structure of a domestic emissions trading scheme. The recommendations of the Task Group echo those of Prime Minister Howard, and suggest that a cautious and measured response towards climate change should be adopted.

This "cautious approach" is favoured by the Government as a means of reducing the economic impact on both business and families by gradually evolving Australia's carbon dependent economy to being carbon constrained.

In this article we'll look at some of the questions raised by the Task Group's report and what they mean for future investment in the energy sector.

Summary of key features

We've already looked elsewhere at the report's main points here, so we'll only briefly recap them here:

• The implementation of a domestic cap and trade scheme that should begin by no later than 2012.
• Energy, industrial and fugitive emissions will be initially covered by the scheme with an emissions threshold of 25 kt of CO2-e (approximately 900 facilities). Agriculture and land use emissions will be excluded.
• Emitters will need to acquire permits equivalent to their annual emissions or pay an emissions fee at a higher price than the value of a permit. Permits will also be able to be banked and used against future emission liability.
• "Free" permits will be allocated on a one-off basis to compensate firms for loss in asset value as a result of the introduction of the scheme.
• Trade-exposed, emissions-intensive firms will be allocated free permits to maintain competitiveness with international competitors not subject to comparable carbon constraint in its country of origin.
• A "safety valve" mechanism which will set a ceiling on the price of permits, to ensure that the cost of complying with the scheme does not become excessive or prohibitive.
• Offsets will be recognised from both domestic and international sources, with offsets undertaken before the commencement of the scheme recognised.

While these key policy features do achieve some certainty as to the long-term framework of the scheme, aspects of the report raise more questions than they answer.

Clarity for business?

One of the biggest issues facing businesses in carbon intensive, and, conversely, renewable industries, has been the lack of policy certainty, resulting in delayed infrastructure investment. The report was commissioned in some part to provide the security needed to encourage infrastructure investment both in traditional energy fields, such as coal, and emerging technologies, such as wind and solar. The report however does not appear to clarify important issues for businesses that will arise with the introduction of a carbon trading scheme. Matters such as the carbon price and the amount of emission reductions required under the Federal scheme are yet to be established and instead, will be set during the initial planning phase in 2007-2008.

Some mechanisms of the scheme, such as the rolling ten year period for which permits will be allocated, potentially make it difficult for substantial projects to be developed and financed, because it will mean that business will have to address the risk for projects that will have a lifetime of longer than ten years or deliver a return on amounts invested over a period of longer than 10 years (as occurs with most major projects). As a result, investors and financers may not accept the risk of changing permit allocation and potential policy changes after that period ends.

Permit allocation

To ease the transition, free permits would be allocated on a one-off basis at the start of the scheme to:

• companies from any covered industry that suffer unexpected disproportionate loss of asset value as a result of the introduction of the trading scheme on a one off basis; and
• to trade exposed, emissions intensive industries to ensure that competition is not prejudiced by the introduction of the scheme.

The allocation of the free permits to trade-exposed industries will be subject to regular reassessment. When the transitional arrangements are withdrawn, these industries will be eligible for one-off compensation for the loss of value of assets.

Over time, companies holding free permits must demonstrate that they are using the world's best practice low emission technologies and, if using higher emissions technology, that firm would have to buy permits from the market. The timeframe for companies to evolve to world's best practice low emissions technologies is not indicated in the report, which gives rise to another investment uncertainty. New investments will also be eligible for free permits but will need to show from the outset that it is using world's best practice low emissions technologies.

United Nations Intergovernmental Panel on Climate Change Report

It is unclear whether the Task Group Report and the Government's partiality for a cautious approach will be consistent with recent international initiatives, particularly with respect to the effectiveness of a low price for carbon and the immediacy required for mitigation efforts.

The Intergovernmental Panel on Climate Change ("IPCC") Fourth Assessment Report is to be released shortly. In advance of this report a number of summary documents, described as "Summary for Policymakers" have been released.

The IPCC Report states that

• mitigation efforts over the next few decades will have a determining impact on opportunities to achieve a stabilisation of carbon levels at concentrations which are less likely to lead to catastrophic environmental effects.
• commencing with a low carbon price may not deliver the carbon reduction required to stabilise emissions
• a carbon price of US$ 20 -50 /tCO2 is required by 2020-2030 (it is not clear whether this could be achieved under the Task Group's scheme).

The report focuses on the benefits of putting a price on carbon in order to provide an incentive to invest in low emission GHG products, technologies and processes, but notes that for this to be achieved, government support (financial, tax credits and market creation) is crucial in the areas of R&D and deployment.

Conclusions

This is a very controversial area, and as expected, the debate on the Task Group's report has been fierce. The ALP, which has committed to a 60 percent reduction on 2000 levels by 2050, has criticised it for assuming that you can either have a healthy economy or a healthy environment.

The Government has responded to this criticism by arguing that a response to the challenge of climate change must take into account Australia's unique circumstances, and not necessarily apply policy framed in Europe, as if "Australia were a small densely populated nation with high winds somewhere east of Denmark", as Prime Minister Howard noted in his address to the Liberal Party Federal Council.

It is unclear whether the recommendations made by the Task Group adequately address the uncertainties surrounding business investment or shed any light on the extent of the reductions expected under any policy that may adopted by the Government.

For further information, please contact Paul O'Donnell.