There are three major concerns with the ERF.

7 May 2014 — Many unanswered questions remain about the Commonwealth Government’s Direct Action plan to reduce carbon emissions. But three loom large out of the recent release of the Emissions Reduction Fund White Paper. The answers to those questions will go a long way to determine whether the centrepiece of Direct Action, the Emissions Reduction Fund (ERF), has any chance of being effective.

The most important of these is the operation of a penalties scheme, called a  “safeguard mechanism”, which will apply to companies that exceed their historical emissions levels – otherwise known as baselines.

By limiting growth in emissions from facilities, the safeguard mechanism could operate as a de facto national cap on emissions. However, it is clear that difficult political decisions around this have been put off by deferring its commencement to 1 July 2015. A key factor in those decisions may well be the state of international climate change negotiations and the success or otherwise of the ERF.

The second question is whether any of the elements of the Direct Action plan outlined in the White Paper will be passed by the Senate.

The third, and most critical, is if Direct Action is implemented whether any companies will think it worthwhile to bid for contracts though the ERF to reduce their emissions.

In relation to the last question, it is evident from the White Paper that changes have been made to the scheme outlined in the Green Paper to encourage companies to bid.

Most importantly, the Government has signalled it might be willing to modify its insistence that contracts only be for a five-year period. Many companies have indicated that this term is too short for many investments that have a longer pay-off period. As a result, the Government has indicated a consultant will be appointed before the commencement of the ERF to undertake market testing and to look at the commercial impacts of alternative contract lengths.

Further, the Government will “retain discretion to enter out-of-auction contracts” for major projects, which can reduce emissions by over 250,000 tonnes of CO2-e a year. This indicates that the Government may be willing to consider large projects in the energy sector, such as coal-fired power stations, although it is unlikely there will be sufficient funds for such an exercise.

Importantly, the White Paper indicates that the Government will have the flexibility to shift ERF funding between years depending on the type of projects already contracted under the ERF. However, while the Government has allocated an additional $1 billion to the ERF, it is now unclear whether there will be ongoing funding after the $2.55 billion now set aside for the fund. The only commitment in the White Paper on this issue is for “further funding to be considered in future budgets”.

There are also measures to encourage the creation of a trading market in Australian Carbon Credit Units (ACCUs) by enabling project proponents to sell them initially domestically and then, at a later date, internationally.

Further, the period in which projects will earn credits will be seven years with the option of different periods for some projects, including 15 years for reforestation and soil carbon projects. This will leave companies with the option of selling ACCUs generated to other buyers after the expiry of an ERF contract. Companies that are unable to meet a contractual obligation to deliver the agreed amount of emission reductions will be required to “make good” by purchasing ACCUs from other Australian projects. However, where projects are affected by factors beyond their control, such as fire and flooding, provision will be made in the contract to vary the quantity and schedule of delivery.

Importantly, the Government appears to have shifted on its position that payment for reducing emissions will only occur at the end of a contract. Instead, the White Paper proposes payment for emissions reductions as they occur during the term of the contract.

The key issue for many companies in deciding whether to participate will be the price that the Government is willing to pay for emission reductions. The White Paper indicates projects will win contracts solely based on cost and the Government will only purchase 80 per cent of emission reductions offered for sale below the maximum the Government is willing to pay. The Clean Energy Regulator will determine this benchmark price in advance of each auction. Only the weighted average price paid across successful bids will be published by the Regulator after each auction. For the first auction, the Regulator will have the discretion to release the benchmark price ahead of bidding to encourage early participation.

Four auctions will be held in the first year, with an initial minimum bid size of 2000 tonnes of CO2-e per year. One of the biggest barriers to participation in the ERF will be the administrative cost to companies in commencing projects, such as ensuring that an emissions reduction method applies to the project and determining what are genuinely additional emission reductions. On this front, the Government has indicated only “new projects” – defined as those that are not implemented before they are registered with the ERF – will be able to bid, with transitional provisions applying to Carbon Farming Initiative projects. To establish that a project will deliver real and additional emission reductions, a proponent must estimate what their emissions would have been in the absence of the ERF.

“Estimates of emissions reductions must be as accurate as practical, recognising that in some cases it may be more practical and cost-effective to use science-based models to determine emission reductions”, states the White Paper. Where emissions data is limited and distinguishing between additional emissions reduction and business as usual situations is difficult, the White Paper indicates the ERF will look to whether projects “clearly go beyond common practice” and potentially have reference to existing metrics, such as the National Australian Built Environment Rating System or Greenhouse and Energy Minimum Standards.

However, where such rating schemes are used, the White Paper indicates the emissions reduction method could prescribe a minimum level of improvement, such as a specified NABERS rating, to encourage projects “that are most likely to deliver real and additional emissions reductions” rather than incremental improvements, which could be business as usual.

At the commencement of the ERF there will be around 30 emissions reduction methods, including methodologies approved under the Carbon Farming Initiative, covering the waste, transport, building energy efficiency and land sector with priority given to the development of further methods that deliver volume and speed to market of projects. It is also proposed to align energy efficiency methods with requirements under state and territory-based energy efficiency schemes, particularly in relation to measurement, reporting and verification.

It is not widely appreciated that the ERF and the safeguard mechanism are separate. For a start, it is proposed to calculate company baselines in different ways for each. However, as is made clear by the White Paper, the two need to operate in tandem if Direct Action is to be effective. According to the White Paper: “The objective of the safeguard mechanism is to ensure that emissions reductions purchased through the Emissions Reduction Fund are not displaced by a significant rise in emissions elsewhere in the economy.”

From the White Paper we know the safeguard mechanism will only apply to around 130 companies with facilities that directly emit over 100,000 tonnes of CO2-e a year, accounting for around 52 per cent of Australia’s emissions. The scheme will be “revenue neutral” to Government but this does not rule out forcing companies to buy carbon permits, including ACCUs, to offset their liability. Notably, baselines will be set at the level corresponding to the year of highest emissions over the last five-year period. However, in the face of strong concern from mining and energy companies, the Government has signalled it is prepared to weaken its operation. The possibility of some form of exemption for the energy sector is flagged to account for the operation of the Renewable Energy Target, which is currently under review.

And for companies that breach their baseline, a dispensation could also be made where it can be demonstrated that the increase is due to an increase in production and not because they have become dirtier. Alternatively, baseline emissions could be averaged out over a number of years.

It will depend very much on the Senate as to what elements of the proposed scheme will eventually be implemented. While the Government has indicated it intends to put funding for the ERF in budget appropriation bills, which are by custom not blocked, the White Paper makes clear that elements of the scheme will require other legislation.

While much of the focus has been on the views of Clive Palmer and his three senators, the position taken by Labor and the Greens in the Senate will be equally critical. After failing to stop the repeal of the carbon tax, Labor and the Greens could shift their focus to amending, rather than blocking, Direct Action legislation. If they did, the safeguard mechanism could well be their focus.

A version of this article was published in The Age, and a full version on the Sparke Helmore website.

Grant Parker is partner at Sparke Helmore. He provides contractual, project administration and advisory services on construction and infrastructure projects.

Marcus Priest is a lawyer at Sparke Helmore. He is a former journalist for the Australian Financial Review.