Emissions Reduction Fund (ERF) White Paper also released

Introduction

With as little fanfare as the Green Paper, the Government released its Emissions Reduction Fund (ERF) White Paper on the eve of Anzac Day. The White Paper sets out the Government's policy decisions on key design aspects for the ERF which were initially canvassed in the Green Paper (see our legal update on the Green Paper here).

The ERF has three primary components:

• crediting emissions reductions;
• purchasing emissions reductions; and
• safeguarding emissions reductions.

The design of the ERF has had regard to three principles, namely:

• lowest-cost emissions reductions;
• genuine emissions reductions; and
• streamlined administration.

The White Paper confirms the initial funding allocation of $1.55 billion (for the first three years of the ERF) and pre-empts the Budget by noting that an additional amount of $1 billion will be added to this amount to cover the fourth year.

The target of a five per cent reduction based on 2000 levels by 2020 has been maintained, notwithstanding the February report from the Climate Change Authority which recommended a target of 19 per cent should be pursued.

Summary

The key aspects of the White Paper, which are set out in more detail below, are:

• The ERF will commence after the carbon tax has been repealed, with auctions to commence in late 2014 and four auctions to be held in the first year.
• The Clean Energy Regulator (Regulator) will administer the auctions, register projects, issue credits and enter into contracts with successful participants.
• To participate in an auction, a project proponent will need to satisfy certain pre-qualification requirements, including having its project registered by the Regulator.
• The contract term for successful projects is likely to be five years, however the Government is going to undertake further market research to determine whether different contract periods need to be awarded in certain circumstances.
• Contracts will be standardised and will include "make-good" provisions, which will allow credits from other domestic projects to be submitted (international units will not be allowed to be used).
• The Regulator will be given discretion to reveal the benchmark price (ie maximum price) for the first auction, but thereafter it will be kept confidential.
• Payment for the emissions reductions will only take place once the credits have actually been issued (that is, there will no upfront payments as may occur under "deeming" arrangements).
• Only "new" projects (ie projects that have not yet commenced) will be eligible for registration.
• Both "activity" and "facility" methods will be used to estimate, verify and credit emissions reductions and work has commenced on developing methods for coal mine gas capture, industrial energy efficiency, building energy efficiency and activities in the transport and waste sectors.
• Existing CFI projects can transition into the ERF and are likely to be the 'early movers' for auction participation given the requirement for pre-registration of projects, which will be dependent upon methods being finalised.
• The "safeguard mechanism" which will seek to ensure businesses do not exceed their "business as usual" emissions (ie baseline) will not commence until 1 July 2015 and there will be further consultation and draft legislation released in early 2015 in relation to this aspect.
• At this stage, it has been determined that the safeguard mechanism will only apply to Scope One (direct) emissions and the threshold will be 100,000 tonnes of CO2-e. Baselines will be set on the highest annual figure between 2009/10 to 2013/14. New entrants will have baselines set based on industry best practice.
• The ERF will be reviewed in late 2015 and the review will focus on operational elements, such as the conduct of auctions and method development.
• The review of the post 2020 targets appears to have been separated from the ERF review which makes sense given that this review will need to take place earlier to comply with the requirements of the international climate change negotiations.

Crediting emissions reductions

Participants wishing to participate in the ERF will need to undertake a project or activity in line with an "emissions reduction method" (method). Methods are intended to apply broadly, rather than be project specific, to enable wide take up of a particular method. Methods may either be activity based or facility based.

The White Paper focuses on the concept of 'genuine' rather than 'additional' emissions reductions and states that emissions reductions will be considered 'genuine' if they would not have occurred without the ERF, they are verifiable and calculated on a conservative basis, and they can be counted towards Australia's emissions reduction target. As foreshadowed in the Green Paper, the 'positive list' approach currently used under the CFI will be abandoned and additionality will be dealt with through the particular method.

Crediting periods

Projects which participate in the ERF will only receive one crediting period. The crediting period will generally be the same as that under the CFI (ie seven years), although there may be the ability for shorter (ie three years) or longer (ie 10 years) crediting periods in particular circumstances. Sequestration projects (ie soil carbon or reforestation) will continue to have a 15 year crediting period.

Methods

Prioritisation of method development will be determined by the Minister for the Environment (Minister) and methods will be developed jointly by the Department of the Environment (Department) and business. It would appear that the private sector can no longer independently pursue method development (as can currently happen under the CFI), however, companies or organisations proposing a large project (ie over 250,000 tonne of CO2-e per annum) could ask the Minister to give priority to developing a method for their project.

The current priority methods being developed include coal mine gas capture, activities in the transport and waste sectors, industrial energy efficiency and building energy efficiency. The Government notes that it intends to use the methods developed under the State based energy savings schemes to develop nationally applicable energy efficiency methods for the ERF.

The Emissions Reduction Assurance Committee (ERAC) will replace the Domestic Offsets Integrity Committee (DOIC) and will be tasked with considering draft methods to advise the Minister whether a proposed method will ensure that credited emissions reductions are genuine (ie additional). Its membership will be expanded to include members with experience covering the additional parts of the economy that will be able to participate in the ERF.

Methods will continue to be published as legislative instruments by the Minister and will be reviewed every four years. Guidance and tools will be made available by the Government to assist proponents in applying methods to their projects and to estimate emissions reductions.

Project approvals, reporting and verification

Projects will be eligible for registration if:

• the project is consistent with a relevant ERF method;
• the project has not commenced prior to registration;
• the activity is not required by law; and
• the activity will not occur as a result of another government programme.

Submissions to the Green Paper suggested that activities that had been implemented as a response to the carbon price should be allowed to participate in the ERF, however this suggestion was rejected by the Government.

Project reports can be undertaken between six months to two years (or five years for sequestration projects), at the discretion of the project proponent (currently under the CFI, the reporting timeframes are between one to five years).

Assurance audits will be required for verifying emissions reductions from projects, with the frequency to be determined based on a risk-based approach.

Credit issuance

The Regulator will approve projects and issue Australian Carbon Credit Units ACCUs (ACCUs) for emissions reductions from those projects. Project proponents will no longer have to be separately registered as a recognised offsets entity, and identity and probity checks will be conducted as part of the project registration process.

Purchasing emissions reductions

The White Paper maintains the Government's previous emphasis that the auction process will be designed to identify the lowest cost emissions reductions available. There will be no "banding" or other weighting or ranking of bids across different sectors. Auction results will therefore be determined purely on the criterion of cost, with other project attributes to be assessed in the pre-qualification phase to ensure that all projects meet minimum requirements.

In terms of the key features of the auction process, the White Paper confirms that:

• The Government has decided to use auctions only to select projects from the start of the ERF, rather than also having a tender process which was proposed as an option in the Green Paper.
• Projects must be registered by the Regulator before a bid can be submitted.
• Registered participants will submit their projects into a competitive bidding process run by the Regulator via sealed bids which specify a price per tonne of emissions reduction.
• participants will only be able to submit one bid for each project and it will not be possible to divide emissions reductions from one project into "parcels" for separate auction bids.
• The Regulator will conduct auction rounds in accordance with published guidelines and procedures.
• The Regulator will set the benchmark price (ie the maximum amount it will pay for emissions reductions) and for the first auction only will have discretion to publish the benchmark price given that no auction price information will be available; the benchmark price will not be made public in advance of subsequent auctions.
• The Regulator will publish the weighted average price paid across successful bids following each auction and aggregated information at the end of each year of operation – this will be the main source of information to assist with price discovery for future participants.
• Competition in the auction process will be created through a "clearance" mechanism involving the Regulator selecting projects that deliver 80 per cent of the emissions reductions below the benchmark price (alternatively, the Regulator may set a budget for the auction and select projects up to that budget).
• The Regulator can make pre-qualification checks prior to an emissions reduction provider being registered to participate in an auction, and may exclude participants on any of several grounds (see further details below).
• Four auctions will be scheduled for the first year, and the Regulator will publish an indicative forward schedule of auctions over the subsequent 12 months (and once there are enough registered bidders to hold an auction, the Regulator will confirm the auction date with four weeks notice).
• There will be an initial minimum project size of 2,000 tonnes CO2-e a year on average over the contract period (although this will not apply to projects approved under the CFI).
• Contracts for successful bidders will have standard terms and will include make-good provisions (see further details below).

Some of the key issues arising from the positions arrived at in the White Paper with respect to the auction and related processes include the following:

Benchmark price

A lot of submissions in response to the Green Paper argued that the Government should publish the benchmark price in advance of each auction to assist potential participants assess the viability of their projects. This was considered by many to be important to ensure adequate participation in the ERF and particularly the early auction rounds.

The Government has not supported these calls by confirming that the benchmark price will only be published in advance of the first auction. For subsequent auction rounds, potential participants will have to rely on the post-auction and annual information released by the Regulator on auction results. The post-auction information will include the weighted average price awarded to successful projects as well as contract related information including the total abatement to be delivered for each project and the duration of each contract.

Registration and pre-qualification requirements

Projects intended for participation in the ERF will need to be registered before an auction bid can be submitted to the Regulator. Before registering a project, the White Paper outlines that the Regulator will have the power to impose a range of pre-qualification checks, which will include requirements for a participant to:

• confirm their identity and probity (ie likely to be similar to the Recognised Offsets Entity "fit and proper person" test under the CFI); and
• propose a schedule of annual emissions reductions estimated in accordance with an approved measurement method.

The Regulator will also have discretion to exclude participants on the following grounds:

• the commercial readiness of the technology or practice;
• the capacity of the project proponent to carry out the project; and
• compliance with ERF contracts and legislation administered by the Regulator.

The White Paper provides no additional information on how the Regulator will make an assessment of these factors. The first two grounds in particular would appear to require the Regulator to develop in-house expertise, or to seek it externally or through requests for further information from the applicant if there is doubt on either. The Regulator would presumably release guidance with criteria on how it would propose to make these assessments. This would be particularly important for participants who are new to the carbon market and/or who have a new technology, in order to assist them with due diligence on their project's viability under the ERF.

It is our view that as a result of the requirement to have projects registered prior to auction, participation in the early auctions will be largely, if not entirely, attended by existing CFI project proponents. Our experience is that method development and project registration, notwithstanding the best efforts of all concerned, inevitably take time to finalise. Given this, and the size of the abatement achieved to date under the CFI (nearly five million tonnes since December 2011), the ERF will need to seriously ramp up during its five year timespan to achieve the ultimate reduction target of 131 million tonnes in 2020.

Contracts

Through the Green Paper process, there seemed to be an almost unanimous view in the market that the proposed five year maximum contract term proposed was inadequate, given that many projects reduce emissions over a longer period and it does not provide a sufficient period to secure project financing or to get other investment decisions over the line.

Despite this, the White Paper confirms the Government's preference for contracts of five years. However, it leaves the door open for potentially longer terms pending the outcome of further "market testing" of projects proposed to be bid into the ERF and the commercial impacts of alternative contract periods. The market testing will be completed prior to the first auction and be done by a consultant commissioned by the Government.

The White Paper confirms that contracts entered into between the Government and successful auction bidders will have standard terms and will detail the price, quantity and delivery time for emissions reductions. It flags that the standard terms used may differ for project aggregators given the different business models involved, but that final design of the standard contracts will be developed in consultation with business and the legal profession in advance of the first auction.

Make good provisions

The White Paper confirms that contracts will include flexible make-good provisions to support the delivery of emissions reductions.

Make good provisions will apply if a proponent is unable to deliver contracted emissions reductions. In these circumstances, a proponent will be able to purchase emissions reductions from another project to make up its shortfall (eg, one that has generated more ACCUs than it has contracted to provide to the Government). The White Paper also outlines that replacement credits can be sourced from domestic projects, but significantly, there is no provision for purchasing international units (eg CERs) to make up a shortfall.

The Government will pay the contract price originally established at auction for units delivered under make-good provisions. The White Paper also flags that contracts may also make provision for liquidated damages that could be payable by the proponent if make-good requirements are not met.

Encouraging large projects

The White Paper indicates that the Government will retain discretion to enter into out-of-auction contracts for major projects which can deliver average emissions reductions above 250,000 tonnes CO2-e a year or 1.25 million CO2-e or more over the contract period. The Regulator will be given the flexibility to use different types of procurement and tendering processes to facilitate this.

The rationale given by the White Paper for making special provision for large projects is that they "can play an important role in reducing Australia's emissions and minimising the administrative costs of the ERF".

The voluntary market

In relation to the ongoing role of the voluntary carbon market, the White Paper indicates that:

• the Government will cancel a Kyoto unit (AAU) where ACCUs are retired by participants in the National Carbon Offset Standard (NCOS) carbon neutral program;
• the Government will review NCOS later in 2014;
• it will be possible for overseas buyers to own ACCUs, but the Government "will not export credits into foreign registries for at least three years as this will make it harder for Australia to meet its five per cent reduction target"; and
• future arrangements concerning the export of ACCUs will be examined as part of the 2015 review of the ERF.

Safeguarding emissions reductions

As anticipated, the Government has deferred the commencement of the safeguard mechanism until 1 July 2015 in order to provide time for more detailed consultation with business on its design and implementation. A separate legislative package will be developed out of this process and be introduced to Parliament in early 2015.

The "safeguard mechanism" is essentially the compliance element of the ERF and in broad terms is premised on a "baseline and credit" model under which covered facilities set emissions baselines (often based on historical emissions or emissions intensity levels) against which credits can be created if emissions fall below baseline levels and penalties applied for exceeding baseline levels.

In terms of policy positions that have been resolved (at least in part), the White Paper indicates that:

• it will cover facilities with direct (scope 1) emissions of 100,000 tonnes CO2-e a year or more (which is said to equate to around 130 entities and 52 per cent of Australia's emissions);
• it will not impose new mandatory reporting obligations on existing businesses;
• it will cover existing and new facilities;
• for existing facilities, absolute emissions baselines over a historical period will be set using existing data reported under NGERS (and it proposes using the highest level of reported emissions for a facility over the historical period 2009-2010 to 2013-20141); and
• for new facilities and significant expansions at existing facilities, baselines will reflect industry best practice (although how this will be determined will be subject to further consultation).

The need for further consultation is outlined in relation to the proposed "flexible compliance arrangements" to be applied to facilities that exceed their baselines, and to new investments.

In relation to the flexible compliance arrangements, the Government has been at pains to emphasise that its objective is not to raise any revenue from the safeguard mechanism and that no budget allocation has been made for any such revenue. It intends to develop its preferred model by working with business over coming months, but flags several options in the White Paper including an emissions intensity test, multi-year compliance periods, or the use of domestic offsets from other emissions reduction projects. As with the make-good provision, there is no suggestion in the White Paper that international units could be used for compliance under the safeguard mechanism.

In relation to the treatment of new investments, the White Paper also floats a few potential issues that will be subject to further consultation. These include how to define best practice, options for treatment of a ramp-up phase by new investments or significant expansions, how to treat industries that are new to Australia, and whether baselines should be different for projects that have and have not taken a final investment decision on a project.

The White Paper also indicates that the specific application of the safeguard mechanism to the electricity sector will take account of the outcomes of the review of the Renewable Energy Target (RET). However, it seems to suggest that there could be grounds to treat the electricity sector differently to other sectors.

Changes to the CFI

It is proposed that the CFI be "folded" into the ERF so that there is only one programme.

Existing CFI projects will, however, remain eligible under the ERF for the remainder of that project's current crediting period.

In order to receive ACCUs, existing CFI projects will be subject to the new ERF reporting and audit requirements from the start of the ERF. The details of reporting and verification under the ERF's risk based approach will be released in advance of the first auction. In the meantime, while it remains uncertain whether the ERF will pass Parliament, CFI projects should continue to report and apply for ACCUs under the existing CFI legislation.

CFI participants, who have been issued with ACCUs, will be able to bid into the ERF as part of the auctions and the Government will purchase ACCUs from those CFI projects that are competitive.

Existing CFI projects can continue to use their current methodology determination, or elect to transfer to a new ERF method.

Transitional period

There will be a transitional period which allows new projects to be approved under existing CFI eligibility rules until 1 July 2015. This will be important for any projects which wish to be backdated as under the ERF eligibility rules it will not be possible to backdate projects and the projects will not be able to be registered with the Regulator if they have already commenced.

Changes relevant to carbon sequestration projects

The ERF proposes to remove the requirement for a project aggregator to hold a proprietary interest in land (such as ownership or a carbon sequestration right) in order to carry out a sequestration project. Instead a project aggregator will only need to show that it has the agreement of the landholder.

The ERF will also introduce a 25-year permanence option for carbon sequestration projects. The number of ACCUs issued to these projects will be discounted by 20% in relation to 100 year projects (that is, significantly less than the 75% discount which was expected to be applied). The White Paper notes that this discount reflects the potential cost to Government of replacing carbon stores if the project is discontinued. The option to carry out 100 year permanence projects will remain, as will the risk of reversal buffer.

The ERF proposes to remove the requirement that ACCUs be issued for avoided deforestation projects over 20 years. This will allow new methods to be developed which allow all ACCUs for an avoided deforestation project to be issued at the time the decision is made not to clear or harvest the forest.

Next steps

Unlike the Green Paper, there is no specific consultation period for the White Paper on the basis that it is stated as representing the Government's final policy position. However, given the significant number of design and implementation issues which are flagged throughout for further consultation, we expect that the Government will be making further announcements in coming weeks and months on consultation for these different elements.

At his press conference releasing the White Paper on 24 April 2014, Minister Hunt indicated that accompanying exposure draft legislation will be released in coming weeks. This will provide a further layer of detail upon which to assess the ERF and associated transitional issues with the CFI, and we expect this will include a period for consultation and submissions to be made.

Upcoming events

Norton Rose Fulbright White Paper seminars
As a result of the Government releasing its ERF White Paper, Norton Rose Fulbright is hosting a number of seminars in Sydney, Melbourne, Brisbane and Perth in mid-May 2014. Each seminar will examine the ERF's key design features, the scope for different project types to participate and how the ERF is likely to interact with other programmes and the carbon market. For more information and to be added to the distribution list please contact Leanne Currie +61 3 8686 6285.

CMI Summit
Norton Rose Fulbright is a gold sponsor of the Carbon Market Institute's Australian Emissions Reduction Summit and Marketplace which is being held on the 5th and 6th of May. At this Summit, the Minister for the Environment will give his first public speech following the release of the White Paper. Click here for more information.

Australian Environment Business Network Forum
Norton Rose Fulbright is supporting an Australian Environment Business Network Forum on "Understanding Australia's future Carbon laws – the impacts and opportunities for business", which will be hosted at our Melbourne office on 16 May 2014. Further details can be accessed here.

Footnote

¹Interestingly, Minister Hunt at his press conference releasing the White Paper on 24 April 2014 indicated this was the Government's preferred approach but suggested the final decision would be subject to further consultation.

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