26 Sep 2013

The Coalition and CFI

by Graeme Dennis, Brendan Bateman, Nick Thomas, Robyn Farmer, Trisha Cashmere

Affirmation of the continuing role of CFI in a new regime is unlikely to provide any short-term relief to those engaged in this area.

The Carbon Farming Initiative (CFI) will be expanded under the new Coalition Government's Direct Action plan (DAP). However, affirmation of the continuing role of CFI in a new regime is unlikely to provide any short-term relief to those engaged in this area.

It is not clear what elements of the CFI framework the Government will change. A lot will depend on the structure of the Emissions Reduction Fund (ERF). However, assuming the current overall CFI structure remains, the Government intends:

  • to broaden the range of methodologies which the Clean Energy Regulator may approve for use in generating Australian Carbon Credit Units (ACCUs) under the CFI, including methodologies for cleaning up power station carbon emissions and delivering energy efficiency in industrial processes; and
  • to create a shorter, 25 year investment option for land-based sequestration projects (instead of the current 99 year requirement).

Presumably, projects will have to be approved under the CFI (or other framework) prior to being eligible to be included in the bidding process under the ERF. The new Minister for the Environment Greg Hunt has indicated that emissions reductions will need to be real, measurable and verifiable. A crucial plank of the Government's strategy is that payments will only be made for abatement after it has been achieved, and not in anticipation of the abatement.

The risks of the Government's CFI strategy, when combined with the ERF, include that:

  • project proponents could bid at unachievable levels in order to be successful without the hoped for carbon reductions ever being achieved;
  • the CFI scheme may be paying for (for example) the closure of inefficient, carbon-intensive and borderline profitable or non-profitable businesses to close;
  • with the removal of the secondary carbon market for ACCUs (when the Carbon Pricing Mechanism (CPM) is repealed), the emissions reductions sought may not be achieved because of a chronic undersupply emissions reduction projects (particularly given some projects may be unviable without upfront funding); and
  • the DAP does not set an emissions cap so there is no overall limit on Australia's emissions to ensure that the 5% target is achieved.

All abatement is to occur domestically

The DAP's stated intention is that all abatement and sequestration must occur domestically. Approximately 60% of the domestic abatement under the DAP is to be sourced from soil carbon projects. This will require a methodology for soil carbon sequestration to be rapidly developed and approved to demonstrate that the abatement is real, measurable and verifiable.

Even if this is done, there remains the practical challenge of achieving the scale of sequestration required to meet the national 5% target, given the technology has not been proven to deliver abatement at the scale required to get close to this figure.

The domestic emphasis is in direct contrast to the CPM. Forward projections estimate that liable entities under the CPM will need to buy overseas abatement to the tune of 100 Mt of CO2-e per annum by 2020 to meet their obligations. Despite the DAP requiring an additional 100 Mt of domestic carbon reductions per annum, Labor says that the Coalition has overestimated the available abatement and underestimated the cost, and point to studies supporting this view.

Market uncertainty and the continuation of the Carbon Farming Initiative

Uncertainty about the future of the CPM has resulted in liable entities taking a conservative approach to managing liabilities under that scheme. There has been relatively little engagement in the carbon market, with few liable entities seeking to hedge the future liabilities.

Similarly, proponents of projects under the CFI have reported some difficulty in proceeding with projects that have a return of less than three years.

The Carbon Credits (Carbon Farming Initiative) Regulations 2011 specify the types of projects that will satisfy the additionality test in the Carbon Credits (Carbon Farming Initiative) Act 2011. In order to include emissions reductions from a broader range of projects as proposed by the new Coalition Government, including soil carbon and energy efficiency in industrial processes, amendments to the current legislative and regulatory framework will be required.

The proposal to expand the range of methodologies has to address the challenge of doing so in a timely manner. One way of doing this might be to import methodologies from overseas, with appropriate adjustments for local conditions (if that is feasible).

So far, the vast majority of projects that have been approved to date for ACCUs are landfill gas, gas flaring or piggery waste projects – other methodologies are not being used. The introduction of new methodologies might help address this, but there is a risk that particular new categories of projects (such as energy efficiency projects) could soak up all available funding under the ERF.

It has been suggested that this could be addressed by "banding" funding to specific categories to ensure that those other projects (particularly in the agricultural sector) get a look in.A similar mechanism is used in respect to credit eligibility under the UK's Renewables Obligation scheme. The problem with this is that it may not result in the least cost abatement being achieved, and lowest cost abatement is one of the Coalition Government's key stated goals.

As indicated earlier, one of the other goals of the CFI is to increase participation in carbon abatement in the agricultural sector, to give this sector the opportunity to benefit from carbon reduction schemes. Given the sophistication of the CFI and the importance of scale in achieving in a cost-effective manner, the Government may need to promote aggregation opportunities, and work with co-operatives or large-scale agriculture operators, in order to redirect the current focus of the CFI towards the agricultural sector, particularly if soil carbon initiatives are to feature in it.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.