Is Australian carbon market shake-up viable?

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The Australian government has accepted the recommendations of an expert panel on an Emissions Reduction Fund (ERF) to incentivise abatement opportunities in sectors that have had limited participation in the fund. The recommendations are expected to allow carbon projects to: earn revenue faster through compressed crediting; allow greater third-party participation in method development; lower administrative costs for projects applying multiple methods; and provide greater market access for small projects through a clearing house.

Proposed changes to the safeguard mechanism could also see large greenhouse gas-emitting facilities rewarded for “transformational” projects to lower their emissions below baselines. While most of these changes have been welcomed by the sector, further work is needed to avoid the potential for unintended consequences to the market.

The ERF has been the centrepiece of Australia’s carbon abatement programme since its inception in 2014, when the government provided initial funding of A$2.55 billion (US$1.75 billion).

An overarching theme of the panel’s findings is that the current arrangements, while achieving some success, could be improved by reducing complexity, and the costs that result from that complexity.

One key proposal is to introduce a statutory burden of “utmost good faith”, a concept borrowed from the insurance industry. This requirement would mean that any participant in the ERF scheme would be bound by obligations to act with utmost honesty and integrity in all dealings with the scheme, at the risk of legal consequences for failure to do so.

Compressed timeline

Many ERF projects are expensive to establish, both in terms of the actual activities undertaken and ensuring that the project complies with the chosen methodology. However, they only receive revenue once they are issued the Australian carbon credit units (ACCUs) that they can sell. In some cases, this occurs many years after the initial expenses have been incurred, and the price of those credits is not guaranteed.

The panel has recommended enabling certain types of projects to receive ACCUs on a “compressed” timeline. In practice, this will mean that certain types of projects can receive credits before the amount of carbon has been sequestered under the current requirements. These projects must involve significant upfront costs in the form of resource outlays or foregone profits, which are not materially offset by carbon revenues and secondary benefits (e.g., reduced energy costs) in the early years of the project.

‘Below baseline’ credits

The more controversial proposal is the creation of safeguard mechanism credits (SMCs) for large emitters, which are subject to limits known as “baselines” on their greenhouse gas emissions under the ERF scheme. This is because of the concern that these credits could undermine the value of ACCUs from carbon abatement or sequestration projects generated by other developers, and that the credits would reward emitters for taking steps that they may have taken even without those credits.

The new proposal is for emitters to be able to generate SMCs for reducing their emissions below those baseline limits. The SMCs would not be offsets; rather, they would amount to incentives for activities to reduce emissions.

The panel also stressed that activities would need to be “transformational” in order to qualify, and proposed that those wishing to take up this opportunity would have to make a public “transformation” statement. Under Australian law, such statements would generally have legal force to the extent that they could not be false or misleading. The panel also made clear that they would be subject to the proposed new requirement of utmost good faith.

While it is encouraging to see policy shifting to support additional emissions reductions activities, the new proposal risks adding a further layer of complexity to the safeguard mechanism, and also undermining existing ACCU markets, particularly if the new SMCs were fungible with ACCUs, or otherwise displace the need for facilities that exceeded their baselines to surrender ACCUs.

Uncertainty about how SMCs would work, and how they would affect existing carbon projects, could have the unintended consequence of destabilising the whole scheme, because it could dissuade potential purchasers from buying ACCUs, and therefore could dissuade developers from undertaking additional projects.

A key issue that links to market viability is that the current baselines are set at levels that can be met by the large emitters with relative ease. This means that it would be relatively easy to achieve reductions that bring them below their baselines. Enabling large emitters to easily generate credits, without a price signal that acknowledges that relative ease, risks undermining the price of all credits, including ACCUs.

The government could resolve this problem by bringing the baselines down meaningfully below current levels, noting that different trajectories may be required for different sectors. That would also put Australia on course to achieve emissions reductions goals at a faster rate, or to exceed those goals, and to align with science-backed targets for emission reductions.

Business Law Digest is compiled with the assistance of Baker McKenzie. Readers should not act on this information without seeking professional legal advice. You can contact Baker McKenzie by emailing Danian Zhang at danian.zhang@bakermckenzie.com.