20 November 2013 — The Clean Energy Finance Corporation has released its submission to the Federal Government regarding the design for an Emissions Reduction Fund as part of the Direct Action policy.
The submission to the Department of the Environment on the Terms of Reference for the Design of the Emissions Reduction Fund makes clear that lending upfront capital is an invaluable source of low cost or negative cost carbon abatement.
As flagged in The Fifth Estate on Monday [18 November], the CEFC’s annual report proved the body could cut emissions at a net negative cost (a profit) and was consistently returning well above the government’s five-year bond rate. Pretty good performance for what Prime Minister Tony Abbott yesterday referred to as “the Bob Brown Bank”.
The agency has also been a strong contributor to the property sector. It’s been a major player in environmental upgrade agreements, funding carbon-abating building upgrades that would not otherwise be tenable.
It has also been working on the development of a green residential mortgage product to replicate international energy efficient housing programs and to incentivise energy efficient new housing construction.
The government’s stated objective for the ERF is to “efficiently and effectively source low cost emissions reductions that will contribute towards our 2020 target”.
The CEFC’s annual report stated it had abated 3.9 million tonnes of CO2 at a net benefit of $2.40 a tonne during its first year.
The CEFC in its submission said it assumed the government referred to “lowest cost” as meaning the lowest cost for government, and this could open the ERF to providing upfront loans that deliver net positive returns.
Barriers to investment
Under a section titled “Cost Reduction through Upfront Crediting”, the CEFC submission said that a major barrier to many projects was upfront capital.
“If a project is being developed to provide return, upon completion it may well generate capital return, but in the interim upfront capital is typically required to cover project development, construction and installation,” the submissions stated.
Such projects – if funded with upfront capital under the ERF – could make competitive offers, as they would only require funds during the construction and commissioning phase, and could then pay the funds back, quite often at a rate above the government bond rate.
“Under this scenario a successful auction participant would receive upfront project funding from the ERF and would be obliged to perform the project, achieve the promised abatement, and return the funds to the government within the abatement project timeframe.”
The CEFC provided a hypothetical example that showed how government could get a return on investment through upfront crediting.
The scenarios involve funding from a bank, funding from the ERF or a scenario where the project proponent offered the government money (negative cost of abatement) for an ERF loan.
The first scenario is where the project proponent borrows from a financier to implement their project.
The second scenario involves ERF payments made upfront by government. There is additional cost to government, but the overall project is delivered at a lower cost to society.
The third scenario presents an option where the proponent has offered the government $150,000 in dividends over and above the government funding within a four year period.
This provides for negative cost abatement to government. An example of where the proponent might be willing to pay the government for the up-front funds and deliver negative cost of abatement (to government) is where the cost of funds:
- Is greater than government cost of funds
- Is less than costs of bank finance
- Allows the bidder to exceed a hard bank loan-to-valuation ratio that would otherwise be insufficient to allow construction to proceed
In the third scenario, the government (and therefore the taxpayer) profits from the project rather than just giving away money, while achieving the same amount of abatement.
Property industry commentators last week said the expected structure of the ERF – providing funding in arrears – was unfairly skewed towards well capitalised larger companies that had the resources to make a case for low cost emissions investments and wait for compensation, while smaller companies lacked this ability and would miss out.
- See our article Direct Action: fact or fiction?
The CEFC submission backed this view, stating that claimants being paid from the ERF after they had proven their abatement rather than upfront meant that those without access to capital to fund projects could miss out.
“Outside of energy utilities, the sectors with some of the biggest carbon saving opportunities – [small to medium enterprises] generally, manufacturing, buildings, mining, agribusiness – have just been through several years of tough trading conditions and are unlikely to be in a position to bear costs up-front,” the submission stated.
Those without access to capital would have to “load up on commercially priced debt to cover the implementation phase and bridge the period between awarding and payment of the grant” or simply not implement the project.
“Deep” building retrofits, because of large capital requirements and long payback periods, were identified as potentially unsuited to funds being paid in arrears, meaning many players in the property industry could miss out on potential abatement opportunities under direct action.
A case study by the CEFC showed a building that received a $500,000 federal grant as part of the Green Building Fund, with finance by the CEFC of $700,000 to complement the grant.
Without the upfront CEFC funding, the building would have most likely continued with a 0 star NABERS rating, the submission stated. However, the project resulted in the building achieving a 5 star NABERS rating, with an abatement of 5500 tonnes of CO2 equivalent over its lifetime.
The cost of abatement to the government was $90 a tonne through the grant. However, without the upfront funding provided by the CEFC, a cost of much greater than $90 a tonne would have been required, the submission stated.
“The reality is that a deep retrofit building upgrade such as the one described above would not prove competitive at an abatement auction and the opportunity would remain unimplemented.”
The private sector can’t be relied on and could lead to poor outcomes
The CEFC warned that a lack of secure upfront funding could lead to poor outcomes, and that relying on the private sector to provide this might not be suitable for many projects.
“The government intends to rely largely on the private sector to fund the projects participating in the ERF auctions,” the CEFC submission stated. “Under this approach there is likely to be a significant funding gap particularly for early first mover projects.
“It would be a poor outcome for the government if projects which were awarded funding under the ERF hadn’t properly assessed their finance prospects or costs and weren’t able to achieve financing. This has been a common problem in a range of sectors expecting to participate and bid into the ERF in which CEFC and Low Carbon Australia have had direct experience.”
Even projects that were low risk and could produce strong emissions reductions may find it difficult to secure private sector funding.
“Whilst the project lender might be willing to take new risks, it is the CEFC/LCAL experience that without a catalysing agent, the banking market is highly reluctant to approve new structures,” the CEFC submission stated.
It pointed to the difficulty of getting the private sector engaged in environmental upgrade agreements. Even though they are very low risk, many banks have withdrawn from the market.
“We are now a number of years into the potential for banks to participate in low risk Environmental Upgrade Agreement transactions and still we have major banks withdrawing from the market as the new product approval process is complex and the individual transaction sizes small in banking terms.”
The CEFC has filled the gap, becoming a leading financier of high profile EUAs, including at Central Park in Sydney and the former Ansett building at 501 Swanston Street, Melbourne.
What the CEFC makes clear in its submission is that without stable access to upfront capital, many worthy projects that could provide government with low cost (or even negative cost) abatement opportunities will not eventuate, and that there is a clear need for a body like the CEFC to operate under Direct Action.
And when you’ve already got the CEFC fulfilling this function, why get rid of it?