01 May 2014

The final design of the ERF? ERF White Paper answers some key questions

by Brendan Bateman, Alison Packham

While the detail of the operational and administrative aspects of the Emissions Reductions Fund still require further work, some areas are much clearer.

Although the Emissions Reductions Fund (ERF) White Paper, released on 24 April 2014, states that it contains the Government's "final design" for the ERF, it is clear that there remains considerable work to be done to finalise both the ERF and the proposed Safeguard Mechanism.

In the lead-up to the release of the White Paper, we posed eight questions it needed to answer to give industry investment certainty and to explain how the Direct Action Plan (DAP) will meet Australia's international emission abatement commitments.

The White Paper largely answers these questions, but some of the specifics of this final design will not be revealed until the release of the draft legislation and the auction guidelines, especially in relation to the conduct of auctions and to the duration of contracts.

It also remains unclear how the ERF will achieve sufficient levels of abatement to reach Australia's international ambition targets.

This article will explain the main elements of the ERF as detailed in the White Paper:

  • administrative bodies;
  • allocated funding;
  • crediting processes;
  • purchasing processes;
  • safeguard mechanism;
  • complimentary measures;
  • transition for Carbon Farming Initiative (CFI) projects; and
  • timing of the ERF review.

Expected timeframe for implementation

The Government has outlined an ambitious timeline for implementation of the ERF:

  • By June 2014: exposure draft legislation ERF released;
  • From July 2014: crediting and purchasing elements commence (subject to repeal of the carbon price);
  • By March 2015: exposure draft legislation for the Safeguard Mechanism;
  • 1 July 2015: Safeguard Mechanism commences;
  • End of 2015: review of ERF.

Administration

The Clean Energy Regulator (CER) will administer the ERF. Its functions will include conducting the auctions, issuing Australian Carbon Credit Units (ACCUs), contracting and making payments, administering reporting and managing compliance.

The White Paper announces the creation of a new body, the Emissions Reduction Assurance Committee, which will replace the existing Domestic Offsets Integrity Committee of the CFI and take on an expanded version of its functions. These largely relate to the assessment of both facility- and activity-based methods and the additionality of abatement achieved by proposed methods.

Crediting

Timing

The crediting and purchasing elements of the ERF will commence "on the repeal of the carbon tax". The Government is no longer assuming that this will occur on 1 July 2014, as has been its previous position.

Pre-qualification

In order for a project to participate in the ERF there must first be a relevant approved method applying to that project, and the project must be registered by the CER.

Technical working groups will be set up to develop a range of ERF methods, building on those CFI land sector methods that are already in operation. These methods will also utilise any State- or Territory-based direct action programs that are currently in operation (such as energy efficiency schemes).

However, as approved methods are to be legislated instruments, given experience with similar exercises internationally, the production of appropriate methods could be a lengthy process. The White Paper makes clear that the Government will prioritise the development of new methods which have the potential to deliver large volumes of abatement, and for which there is likely to be market demand.

The process for calculating "additionality" (that is, the additional emissions that would otherwise have occurred in the absence of the ERF) will be incorporated into the ERF methods. Aside from existing CFI projects that will be transferred to the ERF, only new projects that achieve abatement going beyond common practice will be eligible for funding under the ERF.

After estimating the likely emissions from a proposed project using an approved method, a project proponent will then register their project with the CER. Only registered projects can participate in an ERF auction. Registration effectively provides for pre-qualification of projects as the CER will conduct due diligence on each project and proponent to ensure that the projects can meet contractual obligations for funding.

Eligible projects

Projects will be eligible to receive ACCUs for the duration of the individual project's crediting period. The standard crediting period for projects will be seven years, although the ERF will have flexibility to provide for longer and shorter crediting periods. For example, the soil carbon methodology that is currently being developed will have a 15 year crediting period.

The Government is maintaining its policy that it will not issue ACCUs until abatement is actually achieved, despite receiving submissions of the deterrent effect this may have on small projects that require upfront funding. This is to ensure that payment is only made for actual abatement. However, this presents a large upfront cost to all project proponents (except perhaps those with large-scale projects).

Special terms for large-scale projects

The White Paper indicates that under the ERF, the Government will have the discretion to enter into out-of-auction contracts with projects that are likely to deliver more than 250 000 tCO2-e of emission reductions a year, or 1.25mtCO2-e over a contract period, independent of the standard ERF auction process.

This means that these large-scale projects will not have to meet the requirements of a specific approved method, but can adopt a tailored project-specific method.

Reporting and verification

Projects must report emissions reductions to the CER. Emissions reductions must be independently verified by an auditor registered under NGERS. The CER will apply a risk-based approach to determining frequency and content of these verification reports. The White Paper indicates that the ERF will apply flexible reporting periods to assist project cash flows

Purchasing

Auction process

While the detail of the operation and procedures of the ERF auctions will be presented in CER Guidelines that are yet to be published, we know that there will be four auctions a year and participants will be required to submit a sealed bid for a minimum size of 2000 tonnes. To encourage competition, the Government will only purchase 80% of the emissions reductions that are below the unrevealed benchmark price set by the Government.

The Green Paper indicated that the benchmark auction prices would not be disclosed prior to the auction. The White Paper, acknowledging that this may discourage early participation in auctions, provides that prior to the first auction, the CER will have the discretion to publish the benchmark price. The Government has not, however, committed to this course. The CER will publish the weighted average price of the successful bids following each auction on the Emissions Reduction Fund Register.

Contracts

The Government will enter into standard form contracts with successful bidders. The contract will guarantee purchase of emissions from the project proponent for the duration of the contract. Following the announcement of the five-year contract period in the Green Paper, there was concern that this would deter projects where abatement is achieved over a longer period. Although the Government has said that it will conduct market testing by a commercial consultant in relation to the issue of contract length prior to the first auction, it maintains its preference for five-year contracts.

As indicated in the Green Paper, contracts will contain make good provisions that will apply in circumstances where a proponent is unable to deliver the contracted emissions reductions. The White Paper confirms that this will consist of buying domestic ACCUs, although liquidated damages could be payable if the make-good requirements are not met. The CER will be able to vary contractual obligations if a project is affected by special circumstances outside the control of the project proponent, although a risk reversal buffer will continue to be applied to deal with natural events that impact on bio-sequestration projects.

The contract period will in most cases be shorter than the crediting period for the project. ACCUs generated but not purchased by the Government under the ERF process can be used in the voluntary market, or potentially be available to meet any make good obligations.

Safeguard Mechanism

Despite the importance of the Safeguard Mechanism in ensuring that emitters do not exceed historical baseline emissions after the commencement of the ERF, much of the detail of the operation of the Safeguard Mechanism is yet to developed.

The White Paper confirms that the task of designing the Safeguard Mechanism, which will provide baselines and (possible) sanctions for facilities that exceed their baselines, has been separated from the main ERF legislation and will be the subject of discrete legislation to be released by March 2015. The Safeguard Mechanism is due to commence on 1 July 2015.

The White Paper indicates that the Safeguard Mechanism will only apply to direct (scope 1) emissions and to facilities with direct emissions of more than 100,000 tCO2-e per year, including new investments. This threshold is considerably higher than the 25,000 tCO2-e pa under the Carbon Price Mechanism. In practice, this means that only Australia's top 130 emitters will be covered by the Safeguard Mechanism, equivalent to about 52% of Australia's emissions. The Government has also left open the question whether the electricity sector should be subject to the Safeguard Mechanism. If the electricity sector was to be exempted, this would significantly reduce the amount of Australia's covered emissions.

The White Paper makes clear that baselines under the Safeguard Mechanism will be based on absolute emissions and not emissions intensity factors. The baseline will be set on the highest level of emissions for a facility over the period 2009-2014 – not an average of those emissions, or a rolling average which would permit the baseline to be revised over time. Essentially, the baselines will be set at a historical maximum.

There is presently no proposal to allow baselines to be revised in order to achieve any emissions abatement target. This means that the heavy lifting to achieve Australia's current 5% target, or any post 2020 emissions abatement target, will only come through the ERF and any complementary measures that might remain.

For new or significant expansions of existing facilities, baselines will be set to reflect industry "best practice". What and how industry best practice is to be determined will be subject to further consultation.

The Government also proposes to employ a range of flexible compliance options where baseline emissions are exceeded. These include the option of multi-year compliance periods, and the purchase of credits. It is assumed that any make good for exceeding an emissions baseline will be limited to domestic ACCU's, consistent with the stated policy position for the ERF contract make good provisions.

Complementary measures

The Government has indicated that one way the ERF will meet Australia's abatement targets is for it to work in co-operation with other DAP policies to meet Australia's international emissions reductions obligations. The Green Paper requested submissions on complementary measures to assist in meeting these obligations. The White Paper states that the future 2014 Energy White Paper will include consideration of these complementary measures.

Transitioning from the CFI

The White Paper provides some detail on how land sector projects currently operating under the CFI will transition to the ERF. Essentially, it is expected that CFI projects will participate in the early ERF auctions. The ERF will amend the CFI project start dates to align with ERF projects. CFI methodologies will continue to apply, in a simplified form, under the ERF methods.

New rules relating to the ownership structure of forestry and soil carbon projects are aimed at encouraging aggregation of projects. Under the CFI, these projects can only be approved if the project developer owns the land or has another relevant property right. Under the ERF, the project developer will only have to demonstrate that they have the agreement of the landowner to participate in the ERF.

The White Paper also provides proponents of bio-sequestration projects the option to select a lesser period of permanence than currently exists under CFI. Instead of assuming a 100 year permanence obligation, a proponent can opt for a 25 year permanence period and receive 75% of the credits generated over that period.

Review

The White Paper confirms that the ERF will be reviewed at the end of 2015, after the Government is required to make its international commitments regarding post 2020 ambition. To address market concerns about potential uncertainty arising from a review so early in the life of the ERF, the review will focus on the operational elements of the conduct of the auctions and method development, not the fundamental design of the ERF.

Conclusion

The White Paper has now provided some clearer answers on the design of the ERF mechanism. While the detail of the operational and administrative aspects of the scheme still require further work, some areas are much clearer.

For example, the Government's stated desire to prioritise development of methods which are capable of delivering large-scale abatement and for which there is market appetite means that projects that can deliver abatement quickly to meet the immediate imperative of the 5% 2020 abatement target – such as those in the land fill waste, waste to energy and energy efficiency (industrial and commercial) sectors – are likely to have the advantage in obtaining ERF funding.

Where there continues to remain considerable policy uncertainty is in respect of the Safeguard Mechanism – essential to ensure that any abatement purchased under the ERF is not undermined by increases in overall emissions. Initial indications in the White Paper are that baselines set are likely to err on the side of generosity, and not be subject to review.

However, draft exposure legislation for the Safeguard Mechanism is not expected for another 12 months. Given the centrality of the Safeguard Mechanism to the DAP, and the need for further consultation in relation to aspects of that mechanism, a further White Paper may ultimately be necessary.

 

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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.