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Carbon Pollution Reduction Scheme Bill 2010

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2008-2009-2010

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

 

 

Carbon Pollution Reduction Scheme Bill 2010

 

 

 

 

 

REGULATION IMPACT STATEMENT

 

 

(Circulated by the authority of the Minister for

Climate Change and Water, Senator the Honourable Penny Wong)



 

 



T able of contents

Regulation Impact Statement................................................................................... 1

1)       Background................................................................................................... 1

2)       Medium Term Target Range and Indicative Short Term Trajectory.................... 11

3)       Coverage.................................................................................................... 41

4)       Reporting and compliance............................................................................ 81

5)       Linking the scheme to international markets................................................... 91

6)       Auctioning of Carbon Pollution Permits....................................................... 105

7)       Setting scheme caps.................................................................................. 121

8)       Carbon market........................................................................................... 133

9)       Taxation issues.......................................................................................... 151

10)     Transitional issues...................................................................................... 165

11)     Governance arrangements and implementation............................................ 175

Attachment A: Small Business Impact Statement................................................... 191

Attachment B: Attachment B: Compliance cost assessment................................... 195

Attachment C: Existing measures......................................................................... 231

Wilkenfeld review                                                                                                  235

 



 

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R egulation impact statement

1)      Background

Throughout 2007, the Intergovernmental Panel on Climate Change (IPCC) released three Working Group Reports and a Synthesis Report as part of its Fourth Assessment Report, the latest of its six-yearly major reviews and updates of the science of climate change.

The science of climate change presented in the IPCC’s Fourth Assessment Report in 2007 paints a clear picture: warming of the climate system is unequivocal, as evident from a wide range of measurements. Numerous other changes in climate have been observed in wind patterns, precipitation, sea ice, ice sheets, and in aspects of extreme weather. It is very likely that greenhouse gas increases related to human activity have caused most of the rise in global mean temperature since the mid-twentieth century. [1]

New data and scientific understanding, unavailable in time for last year’s IPCC report, are starting to paint an even more worrying picture of climate change.

The Garnaut Review’s Report of September 2008 suggests that emissions are tracking at the upper bounds of the scenarios modelled by the IPCC. Recent research suggests that the rate and magnitude of climate change over the next century may be at the high end of the range estimated by the IPCC. Global mean temperature and sea-level rise are tracking at the upper end of the range of projections. [2] There is also increasing concern about the stability of the Greenland and West Antarctic ice sheets, with implications for sea-level rise. [3]  

If emissions continue to increase at the current rate, the concentration or stock of greenhouse gases in the atmosphere will be around 1000 parts per million (ppm) of carbon dioxide equivalent (CO 2 -e) in the second half of the century compared to 384 ppm in 2005 and 280 ppm in pre-industrial times. [4] Such a concentration is expected to have severe impacts on our environment (as discussed in chapter 2).

An emissions trading scheme

In recognition of the challenges posed by climate change, the Government has agreed to implement a ‘cap and trade’ emissions trading scheme (the Carbon Pollution Reduction Scheme) in 2010.

An emissions trading scheme is a way of limiting greenhouse gas emissions. By setting a limit on total emissions and allowing businesses to buy and sell permits to emit carbon, the trading scheme will put a price on carbon in a systematic way throughout the economy.

It is important to note that the costs to the community arise not from the Scheme itself but from the Government’s prior commitment to reduce national emissions. Regulatory approaches to reducing emissions would impose higher costs on the community because they would not make use of the incentives created by the market mechanism to draw out all low-cost opportunities to reduce emissions (see box 1.1). While a Carbon tax would put a direct price on carbon, there are other considerations which make a trading scheme the preferred approach (see box 1.2).

As well as driving actual emissions reductions, the introduction of a carbon price provides a financial incentive for investment in low-emissions technology research, development and commercialisation. It will also create an incentive for consumers to reduce the use consumption of carbon intensive products (as these become relatively more expensive).

Box 1.1:  Market efficiency

Consider a stylised example in which there are 10 entities, each emitting one tonne of emissions before the introduction of an emissions trading scheme. The different costs of abatement (that is, the costs associated with reducing emissions) of these entities, from highest to lowest ($10 to $1), are illustrated below.

The Government implements an emissions trading scheme with a cap that limits emissions to eight units across the 10 entities. In this example, this means that eight entities will be able to purchase and surrender permits in order to emit and two entities will be required to abate.

In the chart, the darker bars represent the eight entities that will emit (and surrender permits) and the lighter bars represent the two entities that will abate. The objective of the emissions trading scheme is to ensure that the two entities with the lowest costs of abatement abate.

                An efficient market                  An inefficient market

 

 

 

 



In an efficient market, the entities that abate are those with the lowest costs of abatement. The eight entities with the higher abatement costs will purchase permits for surrender following emission; the two firms with lower abatement costs will abate.

In this situation, the unit price will be $2 (equal to the marginal firm’s cost of abatement). Those firms with a cost of abatement that is less than or equal to the price are better off or unaffected, respectively, if they abate. Those entities with a cost of abatement higher than the price are better off paying for the unit so that they can emit. The direct cost of abatement in the economy is the sum of the two abating entities’ costs; that is, $1 + $2 = $3.

The market is said to be inefficient if any of the eight entities with higher cost of abatement are forced to abate rather than purchase and surrender permits. An inefficient market will mean that the over-all cost of the same level of abatement will be greater than where the market is efficient.

Research undertaken as part of the report of the task group on emissions trading indicated that ‘regulatory’ approaches to addressing climate change were less efficient and more expensive than market based mechanisms. Analysis undertaken as part of the report suggested that use of regulatory measures to reduce costs were roughly twice as expensive as a broad based emissions trading scheme. [5]

Box 1.2 :  Why not a tax

Both an emissions trading scheme and a carbon tax are ways of putting a price on carbon. An emissions trading scheme restricts the quantity of emissions and allows the market to set the price of carbon pollution permits-the carbon price.

A carbon tax increases the cost of emissions by a set amount and allows the market to determine how much abatement to undertake in response - that is, whether it is more cost effective to pay the carbon tax or to undertake abatement.

Where the Government has full information, a carbon tax and an emissions trading scheme can deliver similar economic and environmental outcomes. However, it is rare that the necessary information conditions can be met for a carbon tax and an emissions trading scheme to be equivalent policy instruments.

The key benefit of a tax over a trading scheme is that it fixes the costs of compliance, at least in the short term. In the longer term, the Government is likely to amend the tax to in order to generate an emissions outcome that meets Australia’s international obligations (or is consistent with the chosen trajectory). The other benefit is that, in the absence of international linking, a carbon tax is easier to implement (with reduced transaction costs).

The key benefit of an emissions trading scheme over a tax is that it secures the environmental objective by controlling the quantity of emissions directly. Emissions trading may provide greater long-term policy credibility as the community can see the direct link between the policy instrument and the environmental objective.

Australia ’s international commitments are likely to continue to be defined as quantitative targets so this approach allows international obligations to be managed more effectively.

Emissions trading has emerged as the preferred approach in many other developed countries. In part, this is because domestic emissions trading schemes can easily be linked, giving firms the capacity to access least cost abatement opportunities internationally. As this occurs, carbon prices will equalise across countries, creating a global carbon price, without the need for centralised decision making. Carbon taxes could also be harmonised but this would involve multi-party agreement and would therefore be difficult to achieve in practice.

Emissions trading also allows for mechanisms to help entities manage the uncertainty around future carbon prices. For example, emissions trading allows for derivative financial products to be developed. It is difficult for a carbon tax approach to provide similar means to manage uncertainty around future carbon prices.

This Regulation Impact Statement

As noted above, the Government has already committed to introducing an emissions trading scheme. Out of a concern to begin addressing the challenge of climate change as soon as possible, this decision was taken shortly after the election of the Labor government. A Regulation Impact Statement (RIS) could not be developed in time for this decision. Recognising this, the Prime Minister decided that exceptional circumstances existed and a RIS was not required. A post-implementation review of this decision will be undertaken after the implementation of the Carbon Pollution Reduction Scheme.

While a decision to introduce an emissions trading scheme has been taken, the precise nature of the scheme and the rules and regulations surrounding its operation have not been settled. This RIS provides information to assist in taking these decisions.

This RIS looks at the choice of a medium term emissions trajectory. While this is not the cap on emissions that will exist under the scheme and compel affected industries to limit their emissions, it will have a direct bearing on that cap. As such, this decision will have a significant impact on the businesses and industries affected by the scheme as well as Australia’s contribution toward addressing the climate change challenge.

The RIS also looks at the detailed design issues affecting the scheme. It considers such issues as:

•        Which industries should be included in the scheme

•        The reporting, compliance and governance frameworks surrounding the scheme

•        How pollution permits should be allocated, banked and used

•        Whether the Australian scheme should link with international schemes

•        What taxation arrangements will apply to the scheme

This RIS and the decisions it supports form one step on the road to implementing the Carbon Pollution Reduction Scheme. The Government has already released a green paper that detailed many of the issues to be considered when designing and implementing an emissions trading scheme. That green paper and the submissions made in response to it have been used extensively in the preparation of this RIS. Box 1.3 outlines the consultation undertaken in the development of the design framework for the CPRS. A further round of consultation will be undertaken on the details of the legislation via the release of draft legislation in early 2009.

Following this round of decisions there are still a number of important decisions to be taken. Throughout 2009 the detailed regulations supporting the scheme will be developed. Early in 2010, it is expected that the Government will decide on the precise scheme caps applying under the scheme. At that time the Government will also consider its approach toward the expansion of the scheme to include other industries or sectors. Additional details on the timetable for introducing the emissions trading scheme are included in section 11.

Box 1.3: Consultation

Consultation on the design of the CPRS in an integral part of the development of legislation, regulations and administrative decisions underpinning the scheme.

Prior to the release of the Green Paper, the Department of Climate Change convened a series of roundtables involving peak industry, non-government and land use organisations. These were complemented by an extensive program of bilateral meetings held to discuss specific issues.

The Green Paper was released in July 2008 as a consultation document to air the Governments preferred positions. Stakeholder comment was requested on these preferred positions as well as a range of other issues for which detailed preferred positions had not yet been developed (a deadline for submissions was set at 10 September 2008). Over 1,000 submissions were received in response to the Green Paper. This included submissions from individual businesses, business groups, community groups, environmental organisations and individuals.

Following the release of the Green Paper the Department undertook a series of public meetings to raise awareness of the positions in the Green Paper and to answer questions about the design and development of the scheme. The Department also undertook a number of bilateral meetings with individual business, business groups and other interested stakeholders.

In addition to the release of the Green Paper, the Department also released more detailed discussion papers to elicit additional feedback on particular aspects of the scheme. This included papers discussing the coverage of synthetic gases (August 2008), the waste sector (August 2008) and forestry (September 2008 [6] ).

The Government has also consulted with the states and territories through a working group of the Council of Australian Governments.

A ‘white paper’ detailing the Governments policy positions will be released following decisions on design of the CPRS. Consultation with interested stakeholders on the design of regulations and the implementation of the Governments policies will be ongoing.

Objectives

There are many choices involved in the design of an emissions trading scheme. In making these choices, the Government is guided by certain objectives.

The objective of the Carbon Pollution Reduction Scheme is to:

•        meet Australia’s emissions reduction targets in the most flexible and cost-effective way

•        support an effective global response to climate change and

•        provide for transitional assistance for the most affected households and firms.

In recognition of the need to address climate change the Government has committed to the adoption of an emissions trading scheme. The first part of the objectives recognises that it is desirable for this scheme to be designed and implemented in the most cost-effective way. That is, in considering options for designing the scheme, the objective is to ensure that choices made reflect the balance of costs and benefits that most benefits the community. In many cases, this equates to minimising compliance and administration costs. However in some cases, options with more substantial compliance costs may be adopted as these options have much greater benefits for industry, Government or the community in general.

The second part of the objective recognises that, acting alone, Australia cannot solve the climate change problem. Like other nations, Australia must rely on international cooperation to achieve the necessary reductions in global greenhouse gas emissions. Therefore, it is vital that Australia’s mitigation efforts, including the Carbon Pollution Reduction Scheme, are designed to support an effective global response.



A well-designed and successfully implemented Carbon Pollution Reduction Scheme can contribute to shaping an effective global response by:

•        helping Australia meet its international climate change obligations, including its national target under the Kyoto Protocol [7]

•        demonstrating to other countries that emissions reduction targets can be achieved cost effectively though an emissions trading scheme with broad coverage

•        supporting Australia’s international negotiating position

•        helping to support the development of international emissions trading.

The final part of the objectives recognises that the introduction of an emissions trading scheme is likely to have a disproportionate impact on certain households and industries. To assist in the smooth introduction of the scheme assistance to some affected industries and households may be necessary. In many cases, such assistance is likely to be justified on equity and fairness grounds rather than strict efficiency criteria.

 





2)      Medium Term Target Range and Indicative Short Term Trajectory

Assessing the problem

Australia ’s economy and environment are likely to be disproportionately affected by climate change. As Australia generates only 1.5 per cent of global greenhouse gas emissions, its actions alone cannot avert the worst consequences of climate change: the only solution to the climate change problem is a global one.

A comprehensive global solution is required to slow and ultimately reduce global greenhouse gas emissions to avert dangerous climate change. In determining Australia’s role, domestic and international actions are both important.

As part of developing these roles, the Government committed to a long term goal of reducing Australia’s greenhouse gas emissions to 60 per cent below 2000 levels by 2050, and to use a market-based mechanism — the Carbon Pollution Reduction Scheme (CPRS) — as the primary tool to achieve the emission reductions.

A key issue or problem to resolve in implementing the CPRS is to define the parameters of the emissions constraint in the short to medium term, as a pathway towards the long term goal of 60 per cent emissions reductions below 2000 levels by 2050.

The national emissions trajectory is the rate and timing of emissions reductions to achieve that target.  Setting a 2020 national emissions target range (the ‘medium term target range’) and an indicative short-term trajectory would serve two important functions: signalling to the world the efforts that Australia is making to reduce emissions (including compliance with existing international obligations), and allowing all Australian businesses and households to develop strategies to manage their energy use and efficiently reduce their emissions.

This is particularly important to businesses that are major energy users or direct emitters who will have a liability under the Carbon Pollution Reduction Scheme (the scheme). In deciding on the shape of the national emissions trajectory, it is important to take into account not only the medium and long term goals, but also to signal a likely path towards them.

In the Green Paper, the Government sought feedback on how the trajectory and target range should be defined and communicated. In parallel, the Australian Treasury and others analysed the economic impacts of various national and international emissions reductions scenarios for the Government and for the Garnaut Climate Change Review. The results of these analyses, which were published in The Garnaut Climate Change Review: Final Report (September 2008) and Australia’s Low Pollution Future: The economics of climate change mitigation (October 2008), are relevant to decisions on the level of the target range and the national emissions trajectory.

Objectives of government action

The purpose or objective of the 2020 target range and indicative trajectory is to provide guidance to businesses and households about future emissions reductions, as one of a number of factors influencing planning and investment decisions that are sensitive to future energy and carbon costs. In particular, the medium term target range and trajectory will have a strong influence on the scheme cap which will determine the number of permits issued for the scheme up to 2020.

Setting a target range and indicative trajectory will also support the Government’s other key objective of contributing to a comprehensive global solution that slows and ultimately reduces global greenhouse gas emissions.  In this context as a first step, supplementing the Government’s commitment to reduce emissions by 60 per cent of 2000 levels by 2050 with a 2020 target and indicative trajectory, along with the introduction of the Carbon Pollution Reduction Scheme, could allow the Government to signal credible and robust steps to cut domestic emissions.

Alongside these high-level objectives, the Government outlined additional criteria and objectives in the green paper that have been tailored below as they can usefully inform the setting of targets and trajectories, including:

•        Environmental integrity . The target range and trajectory together should catalyse a policy response that delivers genuine reductions in global emissions and drive the transformation of the Australian economy to a low-carbon future. The environmental integrity of a target is described by the actual emissions reductions it achieves. A very ambitious target or a steep trajectory holds out the prospect of greater environmental benefits, but if they are too ambitious or too steep there is a risk that society will decide that sacrifices to reach the target are not worth making. An overambitious target that is not achieved has less environmental integrity (and effectiveness) than a realistic target that can be achieved and built upon in future years.

•        Economic efficiency . Achieving emissions reductions at the lowest long-term cost maximises our ability to respond to climate change. It is important to achieve our environmental goals as efficiently as possible and get the maximum value out of our mitigation efforts. To do otherwise would waste resources and reduce our ability to respond in the future. See Box 2.1 below for a discussion of economic efficiency in the context of emissions reduction policy.

•        Flexibility . There are inherent uncertainties in climate change science and in the global social and political response to climate change. Policy must be able to respond to changing circumstances in a way that is timely and appropriate. Therefore, policy settings need to provide both medium-term flexibility and clarity for decision making in the short term.

•        International objectives . Consistent with the over-riding objective outlined above in relation to credible Australian action, targets and trajectories should support Australia’s international negotiating objectives and be consistent with international obligations, including trade and climate change treaties. The target range is a central means by which Australia signals the efforts we are prepared to make as part of global endeavours to reduce the impacts of climate change.

•        Accountability and transparency . Business will make investment decisions and householders will make lifestyle choices based on the target range and the trajectory. Decisions on targets and trajectories should be well based and subject to public scrutiny.

•        Fairness . Acting on climate change will impose costs as the economy transforms, but the costs should be spread as equitably as possible across the economy, and no one should shoulder more than their fair share of them.

Box 2.1: How economic efficiency applies to reducing emissions

In general terms, economic efficiency is realised when nothing more can be achieved using the resources available. A system can be considered economically efficient if it produces goods or services at the lowest possible per-unit cost, or if no one can be made better off without making someone else worse off, or if output cannot be increased unless inputs are also increased.

Economic efficiency will be enhanced when policy settings encourage flexibility and focus efforts to reduce emissions on least-cost options. This is a central reason for adopting market-based approaches, such as emissions trading.

The key efficiency issues in setting the trajectory and the medium-term target range are achieving efficient risk management and managing the pace of economic adjustment. Where risk and uncertainty are significant, as is the case in responding to climate change, efficiency will be best achieved when risks are assigned to those who are best placed to judge, act on and manage those risks.

Governments and the private sector have different strengths in judging and managing the risks or likelihoods of different climate change impacts. Neither has a clear advantage in assessing likely future global emissions reductions. National governments control whether they sign future international agreements and take on specific obligations. Businesses have less control over emissions targets or carbon prices, but have many options for managing uncertainty (ranging from reducing emissions and energy use in their operations to using financial instruments) and can choose the best options to fit their circumstances.

Given these different strengths, and the inherent uncertainties associated with climate change, it would not be efficient to allocate all risk either to government or to the private sector. Shifting the full burden of risk management to government would weaken commercial incentives to reduce emissions, would reduce economy-wide efficiency, and could reduce the environmental integrity of the Carbon Pollution Reduction Scheme.

Government should be clear about its policy intent and the processes involved in determining emissions reductions over time. It is appropriate for the Australian Government to put boundaries around the scope and pace of economic adjustment over the next 10 to 15 years.

Options and impact analysis

As noted above, the purpose of the 2020 target range and indicative trajectory is to provide guidance to businesses and households about future emissions reductions, as one of a number of factors influencing planning and investment decisions that are sensitive to future energy and carbon costs.

However, announcing and adhering to a single number for Australia’s 2020 target would lock in the extent of our contribution before key aspects of an agreement are settled, including its overall ambition and the nature of other countries’ commitments. To do so would also transfer financial risk from emitters and energy users to the Government and taxpayers.

The Garnaut Final Report suggested that different targets could form the basis for emissions reductions pathways linked to international action. Under that approach, Australia could proceed along one pathway towards a less ambitious target until the criteria for a second pathway to a more ambitious target were met, at which time Australia could switch pathways.

A potential difficulty with that approach is that uncertainty about the scope and parameters of future international agreements makes it difficult to pre-specify precise pathways and mechanistic switching rules. The international situation is likely to contain ambiguities, which would result in a track switching decision involving significant judgment and discretion, risking apparently arbitrary outcomes for those affected. Furthermore, as the pathways diverge, a switch may cause a large shock to the economy, even with a period of notice.

Thus while at first it may appear that clarity would be provided to business and the community through setting a specific target, the likely need to switch pathways as international developments emerge could be challenging to manage and could lead to some level of dislocation in the economy if the path switching was relatively rapid.  To mitigate this issue, a significant period of notice would be required, which itself would limit the flexibility available to Government.  

Expressing the 2020 target as a defined range allows for the significant uncertainties about international arrangements beyond the first Kyoto commitment period, giving the Government flexibility to respond to changing circumstances and science while limiting the range of potential outcomes for business. The higher boundary of the range could represent Australia’s minimum commitment to emissions reductions, even in the absence of international agreement for the period beyond 2012.

The lower boundary could represent the extent to which Australia will accept tighter targets in the context of a comprehensive global agreement under which all major economies commit to substantially restrain emissions to achieve an ambitious stabilisation goal, and advanced economies take on reductions comparable to Australia’s. However the boundaries would not represent the distinct tracks (suggested by the Garnaut Review).

These high-level options, including the impacts that may flow from defining particular emissions ranges can only be properly considered in the context of modelling analysis and the international negotiating environment.

Before considering the impacts of various emissions reduction pathways, it is important to provide contextual background on current and projected emissions.

Current and projected emissions

An important factor in setting the medium-term target range and the trajectory is the projected level of emissions in the absence of any policy action. Australia’s greenhouse gas emissions are published each year in the National Greenhouse Gas Inventory (NGGI); and in February 2008, the Department of Climate Change also published Tracking to the Kyoto target 2007: Australia’s greenhouse emissions trends 1990 to 2008-2012 and 2020.

Projections in Tracking to the Kyoto target used a combination of ‘top down’ and ‘bottom up’ models. For key sectors, such as stationary energy, the projections used a multiple-model approach, in which the sectoral projection is taken as the average of three independent projections made using different sector models. The overall projection for Australia was produced from the sum of the individual sectoral projections. Chart 2.1 shows an estimate of Australia’s future emissions under current policy settings such as existing measures including the 20 per cent renewable energy target (see footnote in figure 2.1 and Attachment C).

Figure 2.1: ‘Business as usual’ and ‘with measures’ emissions estimates

Source: Department of Climate Change, Tracking to the Kyoto target 2007: Australia’s greenhouse emissions trends 1990 to 2008-2012 and 2020, 2008’. ‘With measures’ includes a range of existing and recently announced mitigation measures implemented across all Governments, such as the new Australian Government measure, the 20 per cent Renewable Energy Target (Attachment C lists a range of these measures).

Table 2.1 shows Australia’s National Greenhouse Gas Inventory for 2005-06 and preliminary estimates of the likely inventory in 2006-07 and 2007-08.

Table 2.2 shows Australia’s likely emissions position in 2007-08, based on the estimated national inventory.

Table 2.1: National Greenhouse Gas Inventory, 2005-06 (actual) to 2007-08 (estimate)

National greenhouse gas inventory (megatonnes)

2005-06 a

2006-07 b

2007-08 b

Energy—combustion of fuels

366

372

377

Energy—fugitive emissions

34

35

36

Industrial processes

28

30

31

Waste

17

17

17

Agriculture

90

86

88

National inventory total c

536

540

550

(a) Department of Climate Change, National Greenhouse Gas Inventory 2006, Commonwealth of Australia, 2008.

(b) Preliminary estimates.

(c) National Inventory excluding land use, land use change and forestry. Net emissions from the land use, land use change and forestry sector were estimated to be 40 Mt in 2006.

Table 2.2: Likely net emissions position, 2007-08

Item (megatonnes)

 

2007-08 a

National inventory total b

(1)

550

National assigned amount under the Kyoto Protocol:

 

 

Assigned amount per year c

(2)

592

Projected adjustments to assigned amount:

 

 

Article 3.3: Deforestation, afforestation and reafforestation d

 

-23

Articles 6, 12,17: Flexibility mechanisms

 

n/a

Total projected adjustments

(3)

-23

Net assigned amount

(4) = (2) + (3)

569

Net balance

 = (4) - (1)

+19

(a)  Preliminary estimates.

(b)  National Inventory excluding land use, land use change and forestry. Net emissions from the land use, land use change and forestry sector were estimated to be 40 Mt in 2006.

(c)  Australia’s Initial Report under the Kyoto Protocol, revised submission 2008.

(d)  As projected for the average of each year in the first commitment period in ‘Tracking to Kyoto 2008’—this projection is subject to significant uncertainty.

Since 1995 emissions have been increasing at a trend rate of around 1 per cent a year, although there is significant annual variability — emissions can vary by up to 5 per cent each year. [8] Many factors drive this variability, including changes in economic activity, population and commodity prices; the characteristics of coal, oil and gas being extracted; and natural climate variability.

For example, emissions change during drought mainly because there are fewer cattle and sheep, but also because there is less water available for hydro-electricity generators, which increases emissions from fossil-fuelled stationary energy generation.

On the other hand, if water shortages result in less cooling in some coal-fired power plants, this can lower emissions. Variation in emissions from land-use change is also affected by the area of land cleared each year and the prevailing weather conditions (for example, whether it was a drought year or a wet year).

Having ratified the Kyoto Protocol, Australia is committed to restraining its national emissions to an average of 108 per cent of 1990 levels across the first commitment period (2008 to 2012). In the event of a post-2012 international agreement, the specification of a target range and the trajectory must take into account, both likely emissions variability and our international obligations, including any association with a post 2020 international agreement.

The medium-term target range can be achieved through a range of measures, but primarily by the Carbon Pollution Reduction Scheme, which will set caps on emissions from covered sectors of the economy. Scheme caps will be set in line with the trajectory, but there will always be a gap between the trajectory and the scheme caps. Not all sectors of the economy will be covered by the scheme in its early years, and not all entities in covered sectors will emit more than the threshold amount for participation, so national emissions will generally be larger than the scheme cap in any given year.

Parameters used in describing the trajectory and target range

Both the trajectory and the target range can be described using three related parameters:

•        Tonnes of carbon dioxide equivalent (t CO 2 -e). This is the internationally accepted measure for greenhouse gas emissions. It describes, for a given mixture and amount of greenhouse gases, the amount of CO 2 that would have the same global warming potential when measured over a specified timescale (generally 100 years).

•        As a percentage relative to a previous year. Australia’s Kyoto target, for example, is expressed as 108 per cent of 1990 levels, while the Government’s long-term target is expressed as a 60 per cent reduction below 2000 levels. Because Australia’s emissions in 1990 were almost the same as in 2000 (547.7 million tonnes [9] and 552.8 million tonnes [10] respectively), percentage reductions below 1990 and 2000 levels for Australian emissions are reasonably similar.



•        As a per capita percentage relative to a previous year. This can sometimes provide a more meaningful comparison of emissions reductions relative to other countries, because it incorporates not only the absolute economy-wide change in emissions over a timeframe, but also the change in population. Per capita reduction targets below 1990 and 2000 levels are quite different, despite similar absolute levels of emissions in those two years, because of different populations in those years. Australia’s per capita emissions were 32.1 tonnes per person in 1990 and 28.9 tonnes per person in 2000 [11] .

Goals for greenhouse gas emissions reductions are sometimes described in terms of a desired global outcome; for example, ‘stabilising emissions at 500 ppm CO 2 -e’, ‘limiting global temperature rise to 2 degrees Celsius’ or ‘avoiding dangerous climate change’. Such goals are only meaningful at a global level. The global atmospheric concentration of greenhouse gases and resulting temperatures will only be stabilised by global efforts to reduce emissions, which are the sum of national efforts. In practice, there is no direct link between one country’s emissions reduction target in 2020 and global stabilisation at a certain long-run concentration, because stabilisation results from the aggregate of all countries’ efforts over time.

Modelling mitigation

To inform the choice of a 2020 target range, it is useful to draw upon the economic modelling of various policy scenarios. The Australian Treasury modelled four scenarios, both for the Government (published as Australia’s Low Pollution Future and referred to as the ‘CPRS scenarios’) and for the Garnaut Climate Change Review (published in the Garnaut Final Report). The Garnaut Climate Change Review also carried out separate modelling exercises of two additional scenarios, which were also published in its final report.

Both the Garnaut Final Report and Australia’s Low Pollution Future presented results from a combination of three top-down, computable general equilibrium (CGE) models: the Global Trade and Environment Model (GTEM), the G Cubed model, and the Monash Multi Regional Forecasting (MMRF) model. GTEM and G Cubed are models of the global economy, whereas MMRF is a model of the Australian economy with state and territory level detail. The CGE models covered four key policy areas:

•        Global: rates and patterns of economic growth, technology development and emissions

•        National: overall performance of the macro-economy and patterns of growth across industries, sectors, states and territories

•        Sectoral: likely technological development and timing and scale of opportunities to reduce energy use and emissions

•        Household: impacts on income, consumption, prices and employment.

The CGE models were complemented by a series of bottom up sector specific models for electricity generation, transport, land use change and forestry.

The Garnaut Climate Change Review worked closely with the Treasury to define the reference case (that is, ‘business as usual’ with no new policies to reduce emissions and assuming no impacts from climate change ). In the scenarios developed for the review, GTEM outcomes were used as an input into the MMRF model, which was augmented by bottom-up sectoral models. GTEM was extended using GIAM (Global Integrated Assessment Model) to model the interaction between the climate system and the economy in estimating global mitigation and climate change damages.

Results from the modelling are described in terms of forgone growth in gross national product (GNP); that is, GNP being a certain percentage less than it is projected to be in the reference case. GNP includes international trade and capital flows and, in a world with internationally linked emissions trading, captures the impact of importing and exporting emissions units.

Different assumptions, different results

Care is needed when comparing modelling outcomes from different exercises. The extent to which modelling results can be compared depends on how similar the models’ methodologies and underlying assumptions are. It is also important to emphasise that, while economic analysis of emissions scenarios published during 2008 contains information about the likely increase in emissions, it is not an emissions projection tool.

It is also important to bear in mind the different purposes and emphases of different scenarios. The modelling results for the scenarios presented in the Garnaut Final Report and Australia’s low pollution future use consistent models but contain varying policy assumptions. In addition, these scenarios (see next section), provide decision makers with some information about the sensitivity of the modelling results to changes in the key underlying assumptions to help inform choices about the carbon constraint, and key scheme design features [12] .  The major differences in assumptions include the following:

•        Modelled avoided costs of climate change. The Garnaut Review identified four types of climate change induced costs

-       Type 1: economic costs of ‘most likely’ climate impacts that are able to be quantified

-       Type 2: economic costs that cannot be estimated with confidence

-       Type 3: cost of the risks that climate impacts are more severe than median projections

-       Type 4: costs that are felt outside markets, such as loss of environmental systems and amenity, and international humanitarian impacts that do not affect Australian markets.

The Garnaut Review incorporated types 1 and 2 into its model.  The review also included in its analysis the benefits to the economy of avoiding some of these costs.  The Treasury work did not include the benefits of avoided costs.

•        Modelled costs of emissions reductions.  The Garnaut Review and the Treasury both modelled the costs of emission reductions in the same way.

•        Coverage. The Garnaut Review scenarios assume that all sectors of the economy are covered by the mitigation policy from the commencement of the modelling period, whereas the CPRS scenarios assume coverage based on the Green Paper (for example, the CPRS scenarios assume that the agriculture sector is excluded until 2015).



•        International action

-       The CPRS scenarios employ a multi-stage approach to international emissions trading, whereby all countries are assumed to have ‘business as usual’ emissions until 2010, after which countries listed in Annex B to the Kyoto Protocol apply the same mitigation effort as Australia. China and higher income developing countries commit to restraining their emissions from 2015, so that China’s emissions allocation triples by 2030 and then begin to fall; India and middle income developing countries take on commitments from 2020, with India’s emissions allocation peaking around 2040; lower income countries take on similar commitments from 2025. Emissions allocations within each group, including advanced countries, are a uniform reduction from each country’s reference case emissions.  This results in total emissions allocations for each group of nations being between 50 per cent and 80 per cent below reference scenario levels by 2050, with developing countries’ emissions being higher than their 2000 levels. International trade in permits is unconstrained from 2020 onwards.

-       In contrast, the Garnaut Review scenarios assume that Australia will take on its proportionate share of global mitigation on a per capita basis.  The model allows for a transition period to enable the current unequal distribution of emissions across countries to ‘contract and converge’ to equal per capita entitlements in 2050. Australia is assumed to meet its targets for the first commitment period of the Kyoto Protocol. All countries are assumed to continue on business-as-usual growth in emissions until 2013, when global mitigation efforts commence with unlimited trading in permits between countries. This represents a stylised optimal post-2012 framework.

•        Emissions-intensive trade-exposed industries. The CPRS scenarios shield emissions-intensive trade-exposed sectors until 2020, after which assistance is phased out, consistent with the preferred position expressed in the Green Paper. The Garnaut Review scenarios do not include any shielding of those sectors, as concerted world action to reduce emissions results in an emissions price emerging in all countries at the same time.

•        Fuel excise. The CPRS scenarios offset the impact of an emissions price on transport fuels through fuel excise changes until 2013.  In contrast, the Garnaut Review scenarios assume that the emissions price impact on transport is fully passed through to consumers.

•        Renewable Energy Target. The CPRS scenarios include the Renewable Energy Target so that 20 per cent of Australia’s electricity comes from renewable sources by 2020.  The Garnaut Review scenarios assume that Australia does not have a Renewable Energy Target once emissions trading commences.

•        Long term emissions reduction target. An emissions reduction scenario needs to specify both a start point and an end point in order to describe the shape of the path between the two points. The CPRS scenarios are consistent with the Government’s stated 2050 target of a 60 per cent reduction below 2000 levels.  The Garnaut Review scenarios involve Australian emissions reductions to 80 per cent and 90 per cent below 2000 levels by 2050.  It is important to note that these 2050 targets are assumptions; they are not results of projections by the models.

Emissions reduction scenarios used for analysis

The consequences of different national trajectories and international arrangements were explored through six stylised scenarios.

In the Garnaut Waiting Game scenario, emissions trading is implemented in 2010 without any clarity about the long-term coverage or ambitions of the likely international agreement to reduce greenhouse gas emissions. This scenario does not include a 2020 target, and the carbon price is fixed. The aim would be to ‘keep hopes alive of an international agreement at reasonable cost, until all opportunities had been exhausted’.  The Garnaut Final Report suggests that this outcome is unlikely, given commitments by the governments of developed countries.

In the Garnaut Copenhagen Compromise scenario, emissions trading commences with a partial (rather than a comprehensive) international agreement to reduce greenhouse gas emissions, and the carbon price is fixed between 2010 and 2013. Under this scenario, the Garnaut Final Report suggests that Australia would reduce greenhouse gas emissions by 5 per cent below 2000 levels by 2020. Like the Waiting Game scenario, the Copenhagen Compromise is assumed to be a transitional scenario that will be superseded by a more ambitious global agreement.

In the Garnaut 550 ppm scenario, emissions trading begins with a comprehensive global emissions reduction agreement in place, centred on the long term stabilisation of global atmospheric greenhouse gases at 550 ppm CO 2 -e. All countries take on obligations from 2013, with the per capita emissions allowances of fast-growing developing countries rising until they meet the per capita levels of the European Union and Japan, and then converging on equal global allocations by 2050. The Garnaut Final Report suggests that, under this scenario, Australia would reduce greenhouse gas emissions by 10 per cent below 2000 levels by 2020.

The Garnaut 450 ppm scenario is similar to the Garnaut 550 ppm scenario, but the assumed global agreement is centred on long term stabilisation at 450 ppm CO 2 -e. The Garnaut Final Report suggests that, under this scenario, Australia would reduce greenhouse gas emissions by 25 per cent below 2000 levels by 2020. Mitigation costs associated with the Garnaut 550 ppm and Garnaut 450 ppm scenarios were modelled by the Treasury, and the results were also published in Australia’s low pollution future.

Australia ’s low pollution future presented a further two scenarios: the CPRS - 5 scenario and the CPRS - 15 scenario. These include the impact of the scheme as presented in the Green Paper, and achieve reductions by 2020 of 5 per cent and 15 per cent, respectively, below 2000 levels. Both assume a staged approach to international action, with developing countries joining the system over the period from 2015 to 2025 as described above. Australia’s low pollution future locates CPRS -5 in a global scenario that would stabilise global atmospheric greenhouse gases at around 550 ppm CO 2 -e by the end of the century; and CPRS -15 in a global scenario with stabilisation at around 510 ppm CO 2 -e.

Key results from economic modelling

Australia ’s low pollution future found that all the emissions reduction scenarios modelled involved only slightly slower economic growth than the reference case.  Consistent with other Australian and international modelling, annual GNP (gross national product) and GDP (gross domestic product) growth is around 0.1 per cent lower over the period to 2050 than it would be without policy action. This results in per capita GNP (measured in 2005 dollars) rising from $50,400 in 2008 to between $54,700 and $55,200 in 2020 across the four scenarios, rather than $55,900 in 2020 in the reference case. GNP is 1.3 per cent to 1.7 per cent below the reference case in 2020 in the CPRS scenarios, and up to 2.0 per cent below the reference case in the Garnaut Review scenarios.

These impacts are equivalent to about 4 months of economic growth, implying that the level of economic activity achieved in January 2020 in the reference case would be achieved in April 2020 in the CPRS scenarios.

Table 2.3 summarises results from Australia’s low pollution future and the Garnaut Final Report.

Table 2.3 : Summary of results of modelled scenarios

 

Refer-ence case b

Garnaut Waiting Game a

Garnaut Copen-hagen Comprom-ise a

Garnaut 550 ppm b

Garnaut 450 ppm b

CPRS - 5 b

CPRS - 15 b

2020 target (per cent below 2000 levels)

No target (40 per cent above 2000 levels)

No target

-5

-10

-25

-5

-15

2020 target in per capita terms (per cent below 2000 levels)

No target (8 per cent above 2000 levels)

No target

-25

-31

-44

-27

-34

2020 GNP per capita (2005 dollars)

$55,870

Not reported

Not reported

$55,000

$54,710

$55,170

$54,970

GNP per capita increase 2005-2020 (per cent)

+22

Not reported

Not reported

+20.2

+19.6

+20.6

+20

2020 GNP reduction below reference case (per cent)

0

-0.9

-1.4

-1.5

-2.0

-1.3

-1.7

2020 carbon price (in 2005 dollars)

Not applic-able

$29.60

$52.60

$34.50

$60

$35

$50

Assumed 2050 target (per cent below 2000 levels)

Not applic-able

No target

60

80

90

60

60

Potential long-term global CO 2 e stabilisation level (ppm CO 2 -e)

Not applic-able

Not reported

Not reported

550

450

550

510

(a)  The Garnaut Climate Change Review: Final report , 2008.

(b)  Australia’s low pollution future, 2008.

This analysis highlights that impacts on the Australia economy result from a combination of national and international factors, including Australia’s emissions trajectory and policy arrangements, the level of global emissions reductions, and the scope and efficiency of global carbon trading arrangements.

The major finding of the Garnaut Review was that the long term economic costs of inaction are greater than the costs of action. That judgment was based on a detailed assessment of the costs to Australia of participating in global emissions reductions compared to the benefits of that global action, including a range of benefits that were not able to be modelled. Importantly, however, the value of economic activity at the end of the century is higher with emissions reductions than without. Although at this time, the total modelled costs of mitigation continue to outweigh

The modelling presented in Australia ’s low pollution future did not assess the benefits of reducing emissions. That report’s major conclusions included the following:

•        The economic cost of reducing Australia’s emissions will be small, although costs to sectors and regions will vary.

•        Even ambitious emissions reductions goals will have limited impacts on global and national economic growth if they are achieved using broad-based, market-oriented policies.

•        Early global action is less expensive than later action, and there are advantages for Australia in acting early if emissions pricing expands gradually across the world. Economies that defer action will face higher long-term costs as global investment is redirected to early movers.

•        A market-based approach allows robust economic growth into the future even as emissions fall, and many of Australia’s industries will maintain or improve their competitiveness under an international agreement to combat climate change.

The Treasury’s analysis suggests that participating in more ambitious global action would involve higher total costs but lower costs per unit of abatement, with the result that the total economic costs of achieving different targets are quite similar. Coupled with the findings of the Garnaut Final Report, this suggests that international willingness to reduce emissions will be a key factor in deciding the most appropriate emissions trajectory and medium term target range for Australia.

International signals

As noted earlier, climate change is a global problem that requires a global response. Although international support for action on climate change has strengthened dramatically over the past decade, the size, distribution and coverage of emissions reductions under the next international agreement are highly uncertain.

Australia is engaged in negotiations for an international agreement to reduce global carbon emissions; to take effect after the first commitment period under the Kyoto Protocol expires in 2012. The national emissions target will form an important part of those negotiations. National emissions targets signal two things: the broad level of global action that a nation considers desirable and achievable; and what that nation considers would be a reasonable contribution to the global effort.

One option that Australia could pursue would be to ‘free ride’ by asking more of other countries than Australia would be prepared to do as part of a global response. However that would likely be widely interpreted as a sign that Australia does not consider that cutting emissions would provide net benefits to all countries, and that Australia does not support ambitious global emissions reduction.

A key finding of the Garnaut Final Report was that a fair and effective global agreement delivering deep cuts in emissions consistent with stabilising atmospheric concentrations of greenhouse gases at 450 ppm CO 2 -e or below would be in Australia’s interests. The logic and findings of the report also strongly suggest that global action towards this goal would also provide substantial global benefits.

However, the report also found it unlikely that global commitment to an agreement centred on the 450 ppm goal would be achieved in the current round of negotiations, and that the most prospective pathway to the goal is to embark on global action that reduces the risks of dangerous climate change and builds confidence that deep cuts in emissions are compatible with continuing economic growth and improved living standards .

Some arguments have been made that because Australia’s emissions are only a small part of the global total, we have little influence on the outcomes of any international agreement to stabilise global emissions. That position misunderstands the dynamics of global action. Australia is one of the top 15 nations in total national emissions, and among the top three in emissions per person.

Together, those 15 nations produce 80 per cent of global emissions. This group, which includes many of the major developed and developing nations, will be centrally involved in deciding the shape and pace of global action. The international community has agreed that developed countries will act first to reduce emissions. This means that all developed countries have the capacity to block or slow progress towards global agreement, but also that developed countries will be able to catalyse greater global action. Showing that action to reduce emissions is consistent with rising living standards will be an important part of achieving an agreement by less developed countries to restrain their emissions in the future.

Options for the path to the medium-term target range

To provide short- to medium-term policy certainty for business, the other architecture components of the RIS supported a fixing of scheme caps for at least five years in advance, to provide guidance on a pathway towards the medium term target range.

These architecture components involve announcing the specific number of permits that are available for allocation or auction for each year, with the option to extend this period of certainty to the end of any international commitment period if it is longer.  The scheme caps would be extended by one year, each year, as required to maintain the minimum five years of certainty.  In early 2010, before scheme commencement, the Government would announce the actual scheme caps for the first five years. 

In advance of the setting of these scheme caps in 2010, the Government could provide some guidance on an indicative short-term national emissions trajectory.  The trajectory or path to the medium-term target range could be defined as a ‘firm trajectory’ with a specific quantity of emissions for each year, or as a multi-year budget with indicative amounts allocated to each year. A firm trajectory would involve setting a target for each year between the scheme start and 2020, while a multi year approach would involve defining a total quantity of allowable emissions over a number of years, and making an indicative (but not firm) allocation to each year within the period.

A firm trajectory would provide a simpler correspondence between the trajectory and the scheme caps for a particular year, but could also result in fluctuations in emissions (for example, from drought or fire) being transmitted to the scheme caps through the projections. It might also lead to an expectation that Australia’s international commitments would be reconciled against actual emissions on an annual basis, rather than over commitment periods as a whole (such as the five year first commitment period for the Kyoto Protocol).

This would involve unnecessary compliance activity, risk unnecessary year-on-year variation, and expose the Government to a range of uncertainties without improving the integrity or efficiency of overall policy settings. A firm trajectory with a target for each year would be incompatible with a 2020 target that is defined as a range rather than as a single number.

An indicative trajectory is able to incorporate banking and borrowing of carbon pollution permits. It would represent Australia’s national ‘emissions allowance’, before any purchase or sale of other eligible compliance units, and before banking or borrowing of permits between years. Actual emissions could be higher or lower than the trajectory without compromising the overall aim of reducing emissions. In aggregate, the national trajectory would be expected to equal the total emissions Australia is allowed to emit in the corresponding commitment period under current and future international commitments.

Interpreting the trajectory as a multi-year, indicative commitment is likely to provide greater certainty to business, with firm annual scheme caps being fixed at least five years in advance on the basis of the indicative trajectory amounts for those years. This will provide clear guidance, while allowing the Government to insulate scheme caps from year-on-year fluctuations in projected uncovered emissions.

Government would remain accountable for ensuring that actual national emissions are consistent with Australia’s international commitments, including through the purchase of eligible international compliance units (for example, internationally assigned amount units, not carbon pollution permits) if emissions are above our assigned amount under an international agreement, or through the sale or banking of units if our emissions are below our assigned amount. This will ensure that actual emissions can be reconciled against the emissions trajectory for each successive multi-year commitment period.

Length of the indicative trajectory

If Australia’s international commitments beyond the first commitment period of the Kyoto Protocol were known, the indicative trajectory could extend to the end of the next commitment period. However, the Government needs to balance the need for business certainty against the need for flexibility to adapt Australia’s climate change mitigation efforts to future international targets. Some stakeholders made submissions to the Green Paper calling for the trajectory to be fixed for long periods, even as far away as 2050.

However, that would potentially jeopardise Australia’s international negotiating position and the Government’s ability to purse Australia’s national interest. It would also transfer significant financial risk to taxpayers, as the Government would need to purchase compliance units internationally to reconcile any differences between actual emissions and international targets.

Because the trajectory is only indicative and the scheme caps are fixed, the length of the trajectory is not critical; however, maintaining consistency between the indicative trajectory and scheme caps announcements would be sensible.

To maintain a reasonable level of guidance, the indicative trajectory can be extended by one year every year from 2010 onwards, so that the trajectory for the current year and four future years are always known. In contrast to the scheme caps, and because the trajectory is only indicative, there is no need for the trajectory to be legislated.

Because the nature of commitments beyond the first Kyoto commitment period is not yet known, it would be imprudent to extend the first trajectory much beyond the end of that period. Restricting the first indicative trajectory to the last two years of the Kyoto commitment period and the 2013 ‘tally up’ year (during which Kyoto Protocol parties ‘make good’ any excess emissions) would ensure that Australia does not put its international negotiating position at risk.

It should also be noted that a common recommendation in submissions to the Green Paper was that the scheme should have a ‘soft’ or gradual start, beginning with a flatter emissions reduction trajectory that gradually becomes steeper over the life of the scheme.

However a number of design features recommended elsewhere in the RIS architecture support a smooth adjustment.

These scheme architecture choices provide the opportunity to effect significant flexibility to enable a smooth initial carbon price pathway.  However they are not explicit choices to compel a particular ‘soft start’ outcome.   A ‘soft’ start to the scheme necessarily means that the national trajectory would have a shallower slope at the beginning and become steeper in later years. A shallow trajectory in the first few years of the scheme would also add to emissions reductions that need to be achieved in later years to achieve a medium-term and long-term target.

It is desirable that any part of the trajectory falling in the Kyoto commitment period is consistent with restraining Australian emissions to an average of 108 per cent of 1990 levels across the period from 2008 to 2012, to avoid the need for direct government purchase of Kyoto compliance units from other countries.

In 2013, the year after the Kyoto commitment period, Australia must ‘tally up’ its Kyoto Protocol accounts and make good on any excess emissions. It is unknown whether future international agreements will be structured in a similar way to the Kyoto Protocol, in that countries restrain their emissions to an average target percentage across a commitment period of a number of years, with a further year thereafter to balance the emissions books.

Consultation

Comments by stakeholders on the medium-term trajectory were generally limited. While a number of stakeholders commented on the size of the medium-term trajectory they were often based on limited additional analysis of the likely impacts of different trajectories.

The Green Paper noted that the government would be making decisions on the medium-term national trajectory in the context of preparing the white paper positions. However, the green paper did not put forward a suggested target for the medium-term trajectory. The Australian Treasury modelling was released in October following the consultation period for the green paper. As a result many of the comments were limited to expressing a preference for a high/low or stringent/moderate medium-term target.

Stakeholder comments on the appropriate level for the medium-term trajectory generally fell into two groups.

On the one hand, environmental groups considered that a stringent target with significant and rapid cuts in emissions is required. For instance Friends of the Earth argued that stabilisation at the 450 level was too high:

At 450 ppm CO 2 , the IPCCs best guess of temperature rise is a 2.1ºC; likely in the range of 1.4 to 3.1. Baer and Mastrandrea [no citation provided] predict that at 450 ppm CO 2 , the risk of overshooting 2ºC is 46 to 85 per cent

This is an unacceptably high level of risk. The impacts that are currently being observed mean that current carbon concentrations of 383 ppm CO 2 are too high. Hansen et al (2008) [no citation provided] show in a recent scientific paper that climate sensitivity (global average temperature caused by a doubling of CO 2 of pre industrial levels) could be as great as 6 degrees. Therefore in the coming decades initial stabilisation of CO 2 concentration should be at least 350 ppm. 

Their submission goes on to recommend that the goal should be zero emissions by 2050 and a 50 per cent cut in emissions by 2020.

The Mullum branch of the Australian Conservation Foundation argued that ‘the 2020 target should envisage an emission reduction of at least 30 per cent and the year 2050 target should envisage Australia becoming carbon neutral’. 

While the analysis referred to in this RIS chapter notes that deep global cuts to emissions (with Australia undertaking its fair share of abatement) are in Australia’s best interests, Australia can not pursue these targets alone. In the absence of a global agreement, undertaking such cuts on a unilateral basis would incur costs to the domestic economy for very limited environmental benefits (as the rest of the world would continue to emit unabated).

Recognising that the main impact Australia can have is on the behaviour of other countries the Australian Conservation Foundation argued that:

To be a credible player in the global effort to avoid catastrophic climate change Australia needs to reduce carbon pollution by at least 30 percent by 2020 (from 1990 levels) and should increase our commitment to 40 percent if other developed countries do the same.

As discussed below an important concern in choosing a medium-term target is the signal that the decision will send to other countries. The size of Australia’s commitments should also take account of the decisions of other countries (including in the context of international agreements).

Another set of perspectives, especially those from many businesses groups, argued for a less stringent target in the early years of the scheme. Many businesses recognised the need for long-term action to address climate change:

Whilst some might argue that Australia should sit back and wait and see - this does not provide the basis for a proactive management of the risks nor does it locate Australia with its international peers in seeking to resolve the inherent challenges associated with climate change.

The Business Council of Australia therefore fully supports the introduction of an emissions trading scheme in Australia capable of international linkages and is pleased to respond to the Australian government’s recently released Carbon Pollution Reduction Scheme Green Paper (CPRS). (Business Council of Australia)

While scientific knowledge is always contestable, the weight of scientific evidence is clear and supports the conclusion that although the risks and costs of reducing greenhouse gas emissions are substantial, they are easily outweighed by the risks and costs associated with not acting to reduce the build up of greenhouse gas emissions. (The Australian Industry Group)

Nevertheless, business groups generally argued for short-term targets that minimised the costs to the Australian economy:

[there exists] reasonable grounds for the trajectory in the early years of the CPRS to be more gradual as opposed to more ambitious (or steeper). It is recognised that this approach would place a relatively greater emission reduction burden on the economy in the latter (post 2020) period of the CPRS, however the progressive commercialisation of alternative generation technologies over the next decade would support the attainment of relatively greater reductions in emission levels post 2020, provided other sectors of the economy meet, or exceed, their proportional emissions reduction obligations under any medium-term emission reduction targets. (KPMG)

The key policy focus of achieving meaningful GHG emissions reductions needs to be achieved while maintaining economic growth and not disadvantaging Australian businesses—especially in the interim period ahead of global carbon regimes. (BP)

The AFGC recommends a soft start to the CPRS with a low and realistic carbon price (of around $5-10 per tonne) set for a period of time that will enable the Australian economy to adjust to the transition. (The Australian Food and Grocery Council)

Qantas supports a transitional approach that would see a realistic and achievable reduction trajectory, a low fixed carbon price or phasing in of obligations for all industries until there are effective global agreements in place with no arbitrary cut of points or tiers. (QANTAS)

The government should transition that Australian economy to the introduction of a carbon price by setting a modest emissions trading cap and ensuring a ‘soft start’ for the first 2 to 3 years of the CPRS. (Santos ltd)

Some business groups proffered opinions on particular trajectories. For instance the Australian Industry Group argued for:

A target range that would reduce our emissions in 2020 to between the level they were in 2000 and 10 per cent below this level. This range could be refined after the United Nations Climate Change Conference in Copenhagen in 2009.

The BCA argued that any medium-term trajectory over 10 per cent will be very difficult and costly for the electricity sector to achieve. It also argues that if the electricity sector finds the target hard to achieve, other sectors will find such a target even more challenging.

Some other stakeholder feedback focussed on the modelling assumptions document released by the Treasury on 3 October 2008.  One criticism raised in a study prepared for the Minerals Council of Australia suggested that:

A significant omission from the Treasury modelling assumptions paper is any guide to the basic assumptions concerning the scale and timing of binding emissions reductions by other leading economies. This is a substantial and critical shortcoming of the paper, and one that is hard to justify given the significant influence that comparable actions by others will have on the costs that will be borne by the Australian economy and by specific economic sectors. 

For example, Treasury modelling based on an assumption or expectation that all major developed and developing economies will agree to comparable emissions reductions by, say, 2013 will inevitably produce a smaller impact on the Australian economy than a (more likely) scenario configured around slower and more haphazard action by major emitters. Given the wide spectrum of the options and their critical impact on the results, it is puzzling that a discussion of these assumptions was not included in the paper

These comments are in relation to the Treasury Assumption Book which was released to aid in stakeholder engagement around the technical assumptions underlying the modelling program. The summary of assumptions and data sources was a technical document and by definition was not aiming at discussing the policy assumptions used in the Treasury modelling. The Government's report Australia's Low Pollution Future released on 30 October 2008 contained a comprehensive outline of the policy assumptions used in the modelling contained in the report.

As briefly noted earlier, the report explored two broad frameworks on the timing and scale of binding emission reductions in economies. And precisely the sort of question raised above was explored by the Australia's Low Pollution Future report. A messier, more haphazard set of actions by major emitters tends to raise the economic cost for the globe when compared against a more inclusive comprehensive program of action. However, the analysis also showed that there were advantages to Australia (and other regions) acting early if emission pricing expands gradually across the world.

Another criticism that has been levelled at the Treasury modelling is the view that the cost estimates for carbon capture and storage (CCS) technology were too low, and that there was a lack of transparency in the use of the embedded marginal abatement cost curves in the modelling exercise, which could underestimate the costs associated with particular emissions reduction targets.

In relation to CCS, it had been suggested that the International Energy Agency estimated the cost of carbon capture and storage to be between USD40 (AUD57) and USD90 (AUD128) per tonne of CO 2 captured and stored.  However they did also go on to say that with the most cost-effective technologies, capture costs are as low as USD 20-40 per tonne of CO 2 .  In any event, the Treasury modelling found that across the full range of scenarios explored, initial emission prices of between $45 to $80 per tonne of CO 2 -e, growing at 4 per cent real per year, brings forward carbon capture and storage for coal.

This is within the range of industry estimates and broadly consistent with the range outlined by Concept Economics ($60-$90 per tonne). The modelling assumes that carbon capture and storage would be technically available from 2020, but finds that under the CPRS scenarios the earliest it is actually deployed in Australia is 2033.

In relation to the marginal abatement cost curves (MAC), the Treasury published detailed information surrounding its use of MAC curves. Pages 256-257 of the modelling report detail the equations and parameters used in the modelling, and how they have been included in the individual models.  In using these cost curves, Treasury undertook significant research to ensure that the parameters used were supported by evidence. The curves employed in the Australian MMRF model are also fully costed.  Price elasticities for substitution between fuels and between energy and other inputs are governed in some cases by fuel switching assumptions built into the models, and in other cases by MACs.  MACs vary by industry, and the detail of the MACs used in the modelling exercise were outlined in Treasury’s Climate Change Mitigation Policy Modelling - Summary of assumptions and data sources.

Conclusion and recommended option

The modelling outlined earlier represents an important input to the calibration of a possible medium-term target range and an indicative short-term trajectory.

As noted earlier it is also the case that the purpose of the 2020 target range and indicative trajectory is to provide guidance to businesses and households about future emissions reductions, as one of a number of factors influencing planning and investment decisions that are sensitive to future energy and carbon costs.

This is important.  The modelling outlined earlier assumed that the financial risk of carbon price uncertainty is efficiently allocated; that is, appropriate levels of risk are accepted by those who are best equipped to manage them.

At the present time, carbon price uncertainty is significant, partly because there is little experience in the economy in pricing carbon, and partly because of uncertainty about the international pace and scale of emissions reductions in next international commitment period.

Business’ exposure to carbon price uncertainty will diminish over time, as businesses participate in emissions trading and ‘learn by doing’. Businesses for which carbon and energy prices are significant will draw on information from a wide range of sources in Australia and overseas to make their own judgments about the evolution of key climate policy settings, and will position themselves accordingly.

Providing a clear signal of the Government’s policy intent through the medium-term target range and the trajectory allows businesses to form judgments about medium- and long-term carbon prices and facilitates appropriate risk management.

Adopting a target range of from 5 per cent to 15 per cent below 2000 levels would be consistent with modelling results from both the Garnaut Final Report and Australia’s low pollution future showing that the expected economic costs of reductions within that range are likely to be modest in aggregate. This range is also consistent with the view that near-term global action is likely to be less ambitious than Australia’s desired long-term outcome.

Such a target is consistent with a wide range of global atmospheric stabilisation goals depending on the distribution of international efforts. The purpose of the range is to signal Australia’s willingness to work towards a worthwhile global agreement that allows for more ambitious action over time as confidence increases and nations accept that deep cuts in emissions are consistent with strong continuing economic growth.

A target of this range would be a credible and constructive contribution to achieving a long-term global solution capable of protecting the planet and promoting Australia’s national interest, which includes supporting Australia’s transition to a low-carbon future. In particular, it compares well to targets proposed by other countries.  Though very few countries have announced specific quantitative commitments to medium term targets, a target range such as that proposed, would represent a comparable effort to the European Union (EU) which has committed to reducing emissions by 20 per cent in aggregate by 2020 compared with 1990 emissions, or 30 per cent in the context of strong commitments by other developed countries.

The EU range represents a 12-22 percentage point reduction relative to the EU's Kyoto target (which is to reduce emissions by 8 per cent below 1990 levels over the 2008-12 period). The population of the EU has been relatively stable over the 1990-2020 period, so its target range translates into a 24 to 34 per cent reduction for each European.

In Australia's case, our population is projected to grow by around 45 per cent over the 1990-2020 period, so the target range proposed would translate to a 34-41 per cent reduction in the per capita emissions of every Australian. In addition, the target range proposed would also represents a 12-22 percentage point reduction relative Australia's Kyoto target (which is to limit emissions to 108 per cent of 1990 levels over the 2008-2012 period.

These comparisons highlight that if we were to adopt such a target range, it would be clear that Australia and the EU were both making serious and credible commitments to reduce emissions so as to place the world on the pathway to effective global action.

The 2020 target range proposed above would also position Australia well to take on further emissions reductions that are likely to be needed beyond that time.

The duration of the commitment period of the next international agreement is not yet known; nor is the overall ambition of the goal for that period. However Australia has much to gain from a global agreement centred on stabilising emissions at lower levels, and should continue to advocate that a more ambitious agreement is desirable, while recognising the immediate priority is to ensure action commences so as to build confidence that deep cuts in emissions are compatible with confirming economic growth and improved living standards

The first indicative trajectory

Current emissions projections (noted earlier) indicate that Australia is likely to meet its Kyoto targets, but that emissions are on an upward path and, in the absence of new policy action, would continue to grow in the future.

The scheme will be the main policy tool to restrain the growth of emissions and position Australia for a low-carbon future. This will involve reversing the growth of Australia’s emissions, and putting the nation on a path consistent with the 2020 target range and a reduction of 60 per cent below 2000 levels by 2050. Managing this transition well is important to ensure that the required emissions reductions are achieved without unnecessary cost.

As noted earlier, it is desirable that any part of the trajectory falling in the Kyoto commitment period is consistent with restraining Australian emissions to an average of 108 per cent of 1990 levels across the period from 2008 to 2012, to avoid the need for direct government purchase of Kyoto compliance units from other countries.

In 2013, the year after the Kyoto commitment period, Australia must ‘tally up’ its Kyoto Protocol accounts and make good on any excess emissions. It is unknown whether future international agreements will be structured in a similar way to the Kyoto Protocol, in that countries restrain their emissions to an average target percentage across a commitment period of a number of years, with a further year thereafter to balance the emissions books.

Emissions in Australia over the first Kyoto commitment period can be thought of as an emissions budget, which can be ‘allocated’ across the five years of the commitment period in a variety of ways. We are currently on an emissions trajectory that is trending up, with emissions lowest at the beginning of the commitment period and highest in the last year (see figure 2.2(a)).

An emissions peak in the middle of the commitment period will provide a stronger signal of the Government’s long term policy intent to reduce emissions by 60 per cent below 2000 levels, and allow for a smoother and more gradual pathway to the 2020 target range. Emissions in the final year of the period will be lower than otherwise, as shown in Figure 2.2(b).

Figure 2.2:  Possible shapes for emissions budgets

Peak at end of Kyoto

commitment period



a

Peak during the Kyoto commitment period



b

Note: These charts are illustrative only and should not be interpreted as actual emissions trajectories.

The first indicative trajectory should be calculated by taking the likely net emissions position for 2007-08 and assigning the remaining emissions budget from the first Kyoto commitment period to the four remaining years of that period, on the basis that national emissions will peak with the introduction of the scheme in 2010-11 and then trend downwards with relatively gentle reductions in the initial years.

The level of the peak and gradient of the slope are consistent with Australia’s Kyoto Protocol target of 108 per cent of 1990 emissions on average over the first commitment period.   The choice of this trajectory provides additional liquidity at the start of the scheme, by drawing on the flexibility mechanisms provided by scheme design choices such as the banking of permits.  This will help to provide more market depth and assist the management of carbon price uncertainty as the market is being established.

That is, the first indicative trajectory should be:

•        in 2010-11, 109 per cent of 2000 levels

•        in 2011-12, 108 per cent of 2000 levels

•        in 2012-13, 107 per cent of 2000 levels.

This indicative short-term trajectory provides some early clarity to business about the possible future scheme cap setting policies in 2010.  Business can plan with some assurance that the scheme caps as set in 2010, will be guided by the indicative pathway outlined above, which peaks in 2010-11 and then trend downwards, but remaining consistent with our Kyoto commitments, which retains flexibility to address different pathways following further international negotiations.   As noted earlier, providing these clear signals about the Government’s policy intent through the medium-term target range and the trajectory allows businesses to form judgments about medium- and long-term carbon prices and facilitates appropriate risk management and planning in the near term.



3)      Coverage

The coverage of the Carbon Pollution Reduction Scheme is an important consideration for Government. It determines how much of Australia’s emissions are captured by the scheme and plays a large role in determining who bears the costs associated with reducing emissions and, to a degree, how significant these costs are.

The consideration of coverage has two broad elements:

•        Which gases should be covered by the scheme?

•        Which sectors should be included in the scheme?

For each sector included in the scheme, additional considerations are:

•        At what point in the supply chain should the obligation to report emissions and surrender permits be imposed? [13]

•        Should the threshold for inclusion in the scheme be different to the 25 kt CO 2 -e/year facility level threshold applicable under NGERS? [14]

Objectives

In deciding on the coverage of the scheme the Government is pursuing two broadly competing objectives.

On the one hand, the coverage of the scheme should be broad, capturing as many sources of emissions as possible. The wider the scope of the scheme, the more the costs of pursuing a particular emissions reduction target are spread across the economy. In addition to ensuring that costs are shared more fairly amongst industries, it also helps to reduce the risks of the carbon pollution reduction scheme distorting the flow of investment toward different sectors. Expanding the ambit of the scheme also opens up additional abatement opportunities ensuring that the cheapest abatement options are pursued, thereby reducing the overall cost to the economy of pursuing any given target (see box 3.1).

Box 3.1: The benefits of wider coverage

For any particular scheme cap the Government may choose, a particular level of ‘abatement’ is required. Abatement refers to activities that will reduce emissions of greenhouse gases or ‘sequester’ (absorb) greenhouse gases already released into the atmosphere. The costs of this abatement are likely to vary across sectors and industries and even between different businesses in the same industry. That is, some businesses will have cheaper options for reducing emissions than others (these options may include changing energy sources, changing production methods to become more efficient or changing the composition of products to use less carbon intensive inputs).

Abatement under the scheme will only be undertaken by ‘covered’ sectors. That is, sectors which are not included in the scheme will have no obligation or incentive to reduce emissions.

If the coverage of the scheme were to be narrow, all required abatement must be undertaken by a smaller number of emitters and a narrower number of technological sources. For instance, if the scheme only covered electricity generation, all abatement required to reach the scheme cap would need to be undertaken in the electricity generation sector. This abatement might come from changes to electricity sources such as increased deployment of wind and solar generation. While some of these abatement opportunities are likely to be low cost (wind generation is already being deployed in some areas) as higher levels of abatement are required the cost will rise. For instance wind generation would need to be sighted in less productive (less windy) areas or more expensive technologies would need to be deployed to further reduce emissions and meet the scheme cap.

It is likely that other sectors would offer abatement opportunities at lower cost than undertaking all abatement in the electricity generation sector. For instance, the capture and flaring of waste methane from landfill sites can reduce emissions at relatively low cost (it is already undertaken in some areas even in the absence of a carbon price). Including the waste sector in the scheme would provide an incentive to undertake these lower cost abatement projects and reduce the need for higher cost abatement in other areas (the electricity generation sector in this example).

Qualitatively, it is clear that, by opening up additional abatement opportunities, expanding scheme coverage will reduce the costs of meeting any particular scheme cap.  Moreover, it is expected that these benefits would be significant — in reporting it’s modelling results (which assumed wide scheme coverage) the Treasury note that:

Emission reductions occur at different rates across sectors and over time. The ability to reduce emissions when it is cheap to do so, through a market based mechanism, keeps mitigation costs as low as possible. [15]

It is instructive to note that the overall costs of the scheme are large — in the order of 1.3 to 2 per cent of GNP in 2020 (with wide scheme coverage). [16] Even relatively small reductions in the cost of abatement would have significant absolute benefits in terms of the reducing the overall cost of abatement under the scheme. The modelling did not examine the impact of excluding particular sectors from the scheme.

However, it is not feasible to quantify the benefits of expanding coverage to particular sectors. To undertake such quantification would require information on the quantity of cost effective abatement opportunities available in each sector at different permit prices. The Government does not have this information.

It should be noted that this lack of information is a key reason why an emissions trading scheme (a market based method) has been adopted to reduce emissions. Even in the absence of this information an emissions trading scheme, which allows businesses to trade permits, should result in the most cost effective abatement opportunities being pursued first. [17] Regulatory approaches (as opposed to market based approaches) to reducing emissions rely on Government being able to identify cost effective abatement opportunities and regulate for abatement in these areas.

Overall, there are benefits to expanding scheme coverage and it is expected that these benefits will be significant. However, it is not possible to quantify these benefits in such a way that would allow meaningful quantitative comparison with the additional compliance costs associated with expanding scheme coverage to particular sectors.

On the other hand covering some sectors or industries may impose significant compliance costs on those industries. This is likely to be the case where there are a large number of small emitters and no practical way of ensuring compliance with the scheme. It is also likely to be a problem where the methodology for measuring emissions has not yet been developed or is highly unreliable.

Overall, when deciding on whether or not to include particular sectors, the objective is to cover as much of Australia’s emissions profile as possible, while not imposing undue compliance costs on business or depending on unreliable measurement methods.

In considering compliance costs it is important to note that in many cases businesses are already subject to a significant portion of the compliance cost burden associated with the scheme. This is because many sectors already have to comply with the National Greenhouse and Energy Reporting System (NGERS). Under this system, a controlling corporation’s group which controls a facility that emits more than 25 kt CO 2 -e/year (and a controlling corporation’s group whose facilities emit (in total) more than 125 kt CO 2 -e/year (falling to 50 kt CO 2 -e/year in 2010-11)) must report their emissions to the Greenhouse and Energy Data Officer.

Where businesses are already recording and reporting emissions, the additional compliance costs mainly relate to changes in accounting practices, assurance of emissions, management reviews and modelling and education of personnel. Box 3.2 gives more detail on the estimation of compliance costs including overall estimates of compliance costs.

In addition to compliance costs, businesses and sectors covered by the scheme will also incur substantial costs associated with purchasing permits to cover emissions or undertaking abatement activities to reduce emissions. In many cases these costs can be passed on to consumers, although this will result in a reduction in demand which will be detrimental to the business. In other cases, companies will be less able to pass on costs and will bear these costs themselves. [18]

While the majority of the impacts of decisions in regard to coverage of the scheme fall on business (and these are the impacts under consideration in this chapter), there will be some (small) impacts on consumers and government (see box 3.3).

Box 3.2:  Compliance costs

Compliance cost estimates for the Carbon Pollution Reduction Scheme are based on estimating the impact of the scheme on eight hypothetical companies. These companies represent different emissions profiles and emissions from a variety of sources. Attachment B details the estimation of compliance costs for the hypothetical companies.

Main compliance costs

For most companies the main compliance costs (beyond those imposed by NGERS) are associated with accounting changes (mainly changes to IT and financial accounting operating systems to accommodate permit liabilities), management reviews of business as a result of the CPRS and third party assurance of emissions reports.

These compliance cost estimates include a number of items which, while not strictly required for compliance, may be undertaken by many businesses in response to the CPRS. For instance, the estimated compliance costs include costs associated with development of financial models to assess the potential for cost pass through. It also includes costs associated with management reviews to understand how the CPRS affects management decisionsand (ongoing) costs associated with modelling cash flows to assist in raising funds to optimise the purchase of permits.

For some hypothetical companies the compliance cost estimates also include data compilation and interrogation costs and application costs associated with applying for assistance (for emissions intensive trade exposed businesses and under the electricity sector adjustment scheme). Applying for assistance under these schemes is voluntary (although it is expected that most eligible businesses will partake) and businesses will take the compliance costs into account in their decisions to participate.

In total these two sets of costs (assistance application and ‘business response items’) form a significant portion of costs for some companies. For instance, they, form around half of the upfront compliance costs for the companies with the highest upfront costs (companies B and D).Finally, it should also be noted that some activities required for compliance will be undertaken alongside regular business activities. For instance all hypothetical companies include a significant cost associated with upgrading accounting systems to capture emissions cost data. Some companies may undertake these updates in the course of other modifications to accounting systems which would reduce CPRS specific compliance costs.

It should also be noted that compliance costs are a business expense and that businesses will receive a tax deduction for many of these costs.

Per business costs

The costs per business costs for the hypothetical companies are described in the table below. While the costs vary across companies, the smaller companies (C, F and H) are lower. This is especially the case for the ongoing costs as these companies do not have to obtain 3rd party audits of emissions reports (see section 4).

 

Hypothetical company

 ‘start up’ costs ($)

On-going costs ($)

A

Large upstream oil and gas company

396 210

278 320

B

Large electricity generator

587 853

274 176

C

Importer of synthetic gas

328 700

67 271

D

Large international industrial processor

904 550

271 274

E

Petroleum refinery

663 675

311 915

F

Small-medium size manufacturer

281 757

50 969

G

Gas retailer

373 217

291 059

H

Waste treatment company

353 061

58 305

Overall compliance costs

A key piece of information when aggregating the compliance costs is the number of companies in each ‘sector’. With the exception of petroleum suppliers, synthetic gas importers and additional fugitive emitters (which are estimates of the number of liable companies and marked in italics below) and synthetic gas suppliers (also an estimate of the number of companies), the Department has estimates of facility numbers drawn from the NGERS RIS and from departmental estimates. These are shown in the table below.

Sector / industry

Number of facilities e

Electricity generation

93

Manufacturing a

203

Mining b

230

Fuel supply: Petroleum

250

Fuel supply: Gas c

40

Additional fugitive emitters

12

Synthetic gas importers

45

Waste

200

Total

1073

a        manufacturing represents emissions from stationary energy and industrial processors

b        mining includes fugitive emissions from mines as well as upstream liabilities for coal suppliers

c        includes fugitive emissions and upstream liabilities for natural gas, LPG and CNG producers

d    This includes additional fugitive emitters who are liable only as a result of gas transmission/distribution pipelines.  

e     Estimates for the number of electricity generators, manufacturing firms and mining firms have been taken from the NGERS RIS (available at http://www.austlii.edu.au/au/legis/cth/bill_em/ ngaerb2007413/memo_0.html). Estimates of the number of petroleum suppliers is from ATO data. The number of gas suppliers, synthetic gas importers, additional fugitive emitters and waste repositories are Department of Climate Change estimates.

However, facility numbers are not appropriate for multiplying out the per business numbers to generate estimates of total compliance costs — many businesses have multiple facilities. However, the average ratio of facilities operated by each business is not known. In one area (electricity generation) it is estimated that the 93 generators are operated by 53 companies. This implies that the number of companies is around 60 percent of the number of facilities. In one sector (gas suppliers) the number of the number of companies is likely to be closer to the number of facilities although many of these companies are likely to liable under the scheme due to emissions from other sources (for instance, petroleum refiners are also likely to be gas suppliers). For other sectors particularly waste, manufacturing and mining the 60 percent number is likely to be more accurate and potentially an overestimate. As a result, for all sectors with the exception of petroleum supply, synthetic gas importers and additional fugitive emitters, the number of facilities has been scaled back using this 60 percent estimate to represent the number of companies.

In general, sectors have been allocated with the hypothetical company which best represents their industry (as shown in the table below). One exception is the petroleum supply sector. This sector is made up of 4 large refiners, 5 smaller independent operators, around 10 fuel blenders and another 230 small producers (bio fuel producers, fuel suppliers in remote areas, mining companies that import directly etc). There is no size threshold for these companies — all entities liable to pay excise and customs duty on petroleum fuels are liable under the CPRS (this includes an unknown number of small businesses). The compliance costs across these companies are likely to vary significantly.

The petroleum refiners have significant emissions derived from a variety of sources (such as fugitive emissions, energy use and downstream liabilities). They may also be eligible for assistance as emissions intensive trade exposed businesses and incur compliance costs as a result of applying for this assistance.

The compliance costs for the remaining companies in the sector are likely to be much smaller. These companies are only likely to have a liability as a result of downstream emissions and their reporting obligations are based on the existing excise system (see below) and compliance for these companies will be much simpler.  As a result, the compliance costs associated with the typical petroleum refiner is a poor representation of the likely costs faced by these companies. The small-medium sized manufacturer is likely to represent a more accurate estimate of the compliance costs for these companies and has been used for the 230 smaller petroleum suppliers. The remaining 20 larger suppliers have been estimated using the petroleum refiner as an appropriate hypothetical company.

In the case of manufacturing, two hypothetical companies are appropriate (the large industrial processor for larger manufactures and the small medium manufacturer for other manufacturers). The number of manufacturers has been split — one third to the large manufacturer and two thirds to the small-medium manufacturer. This represents the split between facilities over and under 125 kt CO 2 -e/year in the NGERS RIS.

Using these estimates of the number of companies, total compliance costs for the sectors is presented in the table below.

Sector or industry

Number of companies

Hypothetical company

Total ‘start up’ costs

Total (annual) on-going costs

 

#

 

$‘000

$’000

Electricity generation

56

B

32 920

15 354

Manufacturing

122

D and F

59 701

15 177

Mining

138

A

54 677

38 408

Fuel supply: Petroleum (lg)

20

E

13 274

6 238

Fuel supply: Petroleum (sm)

230

F

64 804

11 723

Fuel supply: Gas

24

G

8 957

6 985

Additional fugitive emitters

12

A

4 755

3 340

Synthetic gas importers

45

C

14 792

3 027

Waste

120

H

42 367

6 997

Total

767

 

296 246

107 250

Contract revision costs

One set of compliance costs which has not been included in the quantified compliance costs reported above are contract revision costs. Contract revision costs result from the need or desire of businesses to pass on the costs associated with permit purchases (that is, the cost of emissions). In general it is expected that permit costs will be pass on to consumers unless there is some barrier to cost pass through (such as is the case for trade exposed companies or those subject to regulatory pricing controls). In order to assess whether costs can be passed on businesses are likely to go through a process of contract revision. Contract revision costs arise from:

•        Assessing contracts to ascertain those which allow costs to be passed through and

•        Notifying counterparties where costs are being passed through.

Some businesses are also likely to incur costs associated with renegotiating contracts because they are unclear (as to whether costs can be passed through) or unacceptable to one party. The extent to which these costs are compliance costs is unclear as the driving force for the renegotiation is not so much a government requirement but a desire to achieve better business outcomes.

The estimates of contract revision costs included assessing and notifying costs as well as these renegotiation costs.

The estimated contract revision costs vary quite significantly across the hypothetical companies. For six of the eight companies the costs are between $32,000 and $100,000 (these are once off ‘start up’ costs). Two companies stood out as significant outliers. The gas retailer had contract revision costs of around $1.4 million. Stakeholder feedback with DCC indicated that for some gas retailers there were few if any large contracts to be renegotiated suggesting that the compliance costs for these companies would, in practice, be fairly low.

For the industrial processor case, the estimated contract revision cost was $800,000. This represents the contract revision costs associated with significant supply contracts (such as electricity contracts). Again, it is unclear how representative this cost is and, given the number of contracts involved, a significant portion of this cost is likely to be associated with renegotiation.

 

Box 3.3: Coverage impacts on consumers and government

The major impact on consumers associated with expanded coverage will stem from the reduction in overall abatement costs. While the cost reduction described in Box 3.1 will initially accrue to businesses (who must undertake the abatement) these benefits will be passed onto consumers through reduced average prices overall (reflecting more efficient abatement) and higher incomes (reflecting slightly faster economic growth). That is, the impacts eventually passed on to consumers under a scheme with wide coverage will be less significant than under a scheme with narrow coverage.

The one area where there may be costs for some consumers is in relation to the process of some goods and services. While on average price increases would be lower (assuming that a similar share of abatement costs are passed on to consumers across the economy), expanding the coverage of the scheme will lead to relative price increases in different areas. For instance, including the waste sector in the scheme is likely to result in higher local government charges as they pass on the costs associated with emissions abatement in the waste sector. Similarly, including synthetic greenhouse gases is likely to lead to small increases in the price of goods such as refrigerators and air conditioners that use these gases. Consumers that have a particularly high consumption of these goods and services will be most affected by their inclusion in the scheme. However, the overall costs of scheme coverage decisions on consumers are expected to be limited (especially in comparison to business compliance costs).

For Government, the administrative costs associated with expanded scheme coverage are expected to be limited. The major costs associated with running the scheme, such as auction design and operation and establishment of the regulator, will be undertaken regardless of the sectors covered under the scheme. It is also important to note that Government costs associated with reporting emissions are already incurred as a result of NGERS. One area where the Government may incur additional administrative costs is if additional assurance activity is undertaken as a result of covering additional businesses under the scheme (see chapter 4 for a discussion of auditing and assurance). Again, in comparison to the compliance costs for businesses, these costs are expected to be small.

Which gases should be covered?

Parties to the Kyoto Protocol account for six greenhouse gases that contribute most to human-induced climate change (listed in table 3.1).

In designing a domestic emissions trading scheme, one option would be to include only the most common greenhouse gases or those that can be most easily estimated on commencement, with the remaining greenhouse gases included over time. For example, the EU scheme began by covering only carbon dioxide. This option would not necessarily simplify the scheme and could complicate emissions reporting. Under NGERS entities are already responsible for reporting emissions of all six greenhouse gases from their facilities. If the trading scheme only covered carbon dioxide (for instance) companies would have to separately estimate the quantum of carbon dioxide released from their facilities rather than relying on existing estimates of emissions. This option would also limit scheme coverage and create discrepancies between the scheme’s emissions reporting and the reporting in Australia’s national emissions inventory (which forms the basis for international obligations).

An alternative option would be for the scheme, from commencement, to cover all the greenhouse gases included in the Kyoto Protocol. [19] As this approach is consistent with current reporting obligations, it would not add to implementation risks or to compliance costs. This option would ensure that the incentives created by the scheme align with the desired environmental goal as defined under the international climate change framework.

The preferred option is for the scheme to cover all six ‘Kyoto’ gases from commencement.



Table 3.1:  Kyoto Protocol gases—global warming potential

Kyoto gases

Global warming potentials

Carbon dioxide (CO2)

1

Methane (CH4)

21

Nitrous oxide (N2O)

310

Sulphur hexafluoride (SF6)

23,900

Hydrofluorocarbons (HFCs)

140-11,700

Perfluorocarbons (PFCs)

6,500-9,200

Source: Intergovernmental Panel on Climate Change Second Assessment Report: The Science of Climate Change.

Which sectors should be covered?

The Kyoto Protocol sets out seven sectors for reporting human-induced greenhouse gas emissions:

•        Stationary energy : primarily carbon dioxide emissions from fuel combustion for electricity generation, and energy production in the petroleum refining, manufacturing, construction and commercial industries and for domestic heating

•        Transport : primarily carbon dioxide emissions from the direct combustion of fuels for road and rail transport, domestic aviation and shipping

•        Fugitive emissions : methane, carbon dioxide and nitrous oxide emitted during the production, processing, transport, storage and distribution of coal, oil and gas

•        Industrial processes : emissions from chemical reactions associated with manufacturing processes, mineral processing, and chemicals and metal production

•        Waste : primarily methane and nitrous oxide; includes emissions from solid waste sent to landfill and from the treatment of domestic, commercial and industrial wastewater; and solvent and clinical waste incineration

•        Land use, land-use change and forestry : in this sector, only emissions from land-use change activities — reforestation and deforestation — are counted towards Australia’s Kyoto target:

-       Agriculture: primarily methane and nitrous oxide from livestock and cropping

-       Reforestation: conversion of land used for other purposes to forested land

-       Deforestation: conversion of forested land to alternative land uses.

Figure 3.1 sets out Australian emissions in each sector.

Figure 3.1: Australia’s national emissions profile in 2006

Source: National Greenhouse Gas Inventory 2006 , Department of Climate Change

This section looks at the merits of including each sector in the scheme. As outlined above, where these sectors are covered, it also looks at who should be responsible for reporting emissions and surrendering permits.

A separate subsection of this paper (which follows stationary energy and transport — the principle fuel users) looks at the role of the fuel (coal, gas, petroleum) production and distribution sector in reporting emissions and surrendering permits. While entities in this sector are not directly responsible for the emissions resulting from the combustion of the fuel they produce, imposing reporting requirements at this stage may be more efficient than imposing requirements on the downstream users (the ‘direct’ emitters).

Stationary energy

Stationary energy contributes around 50 per cent of Australia’s emissions and is the fastest growing source of emissions. [20] Most emissions from this source are from the electricity generation sector, which consists of around 100 large facilities. The remaining emissions are from direct combustion of fuels by large and small emitters in the petroleum refining, manufacturing and construction industries, with small contributions from home heating, on-site diesel generation, and on-farm machinery.

Site-specific emissions estimation methodologies are used to estimate emissions from most large emitters. [21]

Obligations could be applied under the scheme to every household that combusts fuel. However this would have very high compliance and administrative costs.

Around 90 per cent of emissions from this source can be covered by applying direct scheme obligations to around 100 power generation facilities and to around 200 large manufacturing facilities whose emissions exceed 25 kt CO 2- e/year (the existing NGERS reporting threshold). [22] Estimates of compliance costs for large stationary energy emitters are between $904,550 and $281,757 (start up costs) and $274,176 and $50,969 (annual ongoing costs). Using company numbers described in box 3.2, this would imply total compliance costs of around $93 million (start up) and $31 million (ongoing).

Because stationary energy contributes a large and growing proportion of emissions to Australia’s total emissions, coverage of this sector is critical to achieving any substantial cuts in emissions.

The remaining 10 per cent of stationary energy emissions could be covered by lowering the emissions threshold. Depending on the threshold chosen, this could result in coverage of small entities, whose participation in the scheme would not be cost-effective. That is, the compliance costs associated with imposing scheme obligations on these entities would be significant given their emissions levels.

An alternative option is to impose scheme obligations for the remaining stationary energy emissions on upstream suppliers of coal, natural gas and liquid fuels. That is, rather than directly paying (in the form of permits) for the emissions, smaller emitters would pay higher fuel prices as upstream fuel suppliers purchase permits to cover emissions from the use of the fuel and pass on the costs to downstream users. This approach would involve fewer additional compliance costs as there will be far fewer upstream suppliers and in many cases they are also likely to have scheme obligations for their direct emissions (and therefore already incur significant compliance costs as a result of the scheme). This option would also achieve near universal coverage of emissions, where as the alternative (lowering the threshold would still leave a portion of emissions uncovered).

All Green Paper submissions on the issue were supportive of the Government’s proposed inclusion of stationary energy.

The preferred approach is to cover all entities whose emissions are greater than 25 kt CO 2 -e/year. While this would entail significant compliance costs, the share of emissions associated with this sector make its inclusion in the scheme critical. These costs would be greater if there was a lower threshold. Entities with emissions less than 25 kt CO 2 -e/year would be covered indirectly via obligations on upstream fuel suppliers. Specific obligations for each type of fuel are discussed below.

Transport

Transport emissions account for around 14 per cent of Australia’s emissions. Road transport contributes almost 90 per cent of transport emissions, with the remainder coming from rail, domestic aviation and shipping. [23]

Australia has millions of motorists and a significant number of freight companies, making it impractical and/or costly to apply scheme obligations directly to these emitters. Restricting coverage to large direct emitters, such as freight companies whose emissions exceed 25 kt CO 2 -e/year and who have obligations under NGERS would result in coverage of only 30-40 per cent of transport emissions. It would also lead to significantly different impacts on closely competing freight companies on either side of the emissions threshold.

As a result, the only feasible option for including transport in the scheme is to apply the scheme requirements to upstream fuel suppliers. This would impose obligations on around 250 upstream producers (petroleum suppliers). As discussed in box 3.2, the compliance costs associated with imposing obligations on upstream (excisable) fuel suppliers is estimated to be around $78 million (start up costs) and $18 million (annual ongoing costs).

As with expanded coverage generally, the benefits associated with coverage of the transport sector is that it opens up additional abatement opportunities and lowers the overall cost of meeting any given scheme cap. Abatement in the transport sector is likely to occur through substitution in transport modes (For instance by taking public transport instead of driving and using rail for freight instead of road transport) and substitution toward more fuel efficient vehicles.

The Government has already decided (as part of the Green Paper process) that if transport is included in the scheme, it would offset the effects on households, on-road business users and agricultural and fishing industries for the first three years of the scheme. Heavy vehicle road users will have the initial impact of the scheme offset for the first year. This will occur through a cent for cent reduction in excise which will offset the increase in fuel prices associated with the introduction of the scheme.

There was strong support for inclusion of transport in the scheme (state governments, National Transport Commission, BP, Tourism and Transport Forum, QR Ltd) both as a large source of emissions in Australia and also to reduce abatement costs through maximal coverage. One concern related to the effectiveness of including transport at this point in time, given that the Government has already committed to offsetting the impacts of the CPRS for the first three years. As discussed below (in the context of covering petroleum), the preferred position at this stage is to cover transport from the beginning of the scheme. Such coverage will also drive changes in the behaviour of consumers considering purchase of new vehicles leading up to and during the transition period. Other stakeholders argued for additional complementary measures, including vehicle efficiency standards and investment in public transport, to assist the transition to lower emission forms of transport (in a sector with a relatively low elasticity of demand). While there may be merit in adopting complementary measures if transport were permanently excluded from the scheme, the administrative and compliance costs associated with establishing such measures would not appear to be warranted in the context of the limited period of offsetting implied by the Governments commitment.

Overall, transport accounts for a significant portion of emissions in Australia and the sector also has opportunities for abatement. As a result, its coverage in the scheme would entail significant benefits. While there are also compliance costs associated with it’s coverage, the judgement is that the benefits of including transport outweigh these costs. This is the preferred option.

Fuel suppliers

As discussed above the most efficient way of covering emissions from small emitters in the transport and stationary energy sectors is to place obligations on fuel suppliers rather than directly on the emitting entity. The amount of greenhouse gas emissions from most fuel sources is directly related to the quantum of fuel burnt. As a result fuel suppliers would know that a unit of fuel, once burnt, would yield a particular quantum of greenhouse gases using national default methodologies and would need to purchase enough permits to cover these emissions. The cost of the permits would be included in the price of the fuel thereby providing an incentive for users to reduce fuel use and greenhouse gas emissions.

For the purposes of determining the best way of covering fuel in the scheme, suppliers can be split into two categories:

•        those who are covered under existing excise and customs duty arrangements (mostly suppliers of petroleum products)

•        other suppliers who are not covered by excise and customs duty arrangements (such as coal, natural gas and LPG suppliers).

Petroleum suppliers

Suppliers and distributors of petroleum products are liable to pay excise and excise-equivalent customs duty on these products. The excise and customs duty arrangements provide a well established administrative framework for determining the amount of fuel supplied, netting out fuel sold internationally and to other liable entities (to remove double counting) and ensuring compliance with excise and customs law. The existence of the excise arrangements provides a unique vehicle to use for the purposes of the scheme. As fuel suppliers and distributors already know the quantum of fuel supplied (this is reported to the Australian Taxation Office and Australian Customs Service on a regular basis) all that would be required under the scheme is that they surrender a quantum of permits to cover emissions from the combustion of this fuel. Using an existing reporting mechanism reduces any additional compliance costs that would come from establishing a new system.

It is estimated that there are around 250 entities responsible for remitting excise or customs duty on petroleum products. These entities would incur direct liabilities under the scheme (that is they would need to obtain and surrender permits). Unlike all other areas of the scheme (where the 25 kt CO 2 -e/year limit is likely to ensure that small businesses are not captured by the scheme) a number of the fuel excise remitters are small business. The majority of petroleum products are supplied by around 4 major refiners/importers, 5 smaller independent operators and 10 fuel blenders. The remaining entities are small suppliers such as biofuel producers, fuel suppliers in remote areas, mining companies that import fuel directly and ‘joint user hydrant’ installations that supply fuel at airports (a number of which are likely to be small businesses).

As discussed in box 3.2, the compliance costs associated with the inclusion of upstream petroleum suppliers are estimated to be around $78 million (start up) and $18 million (ongoing). This assumes that there are 20 large liquid fuel suppliers (refineries, blenders and importers) who are represented by hypothetical company E (the petroleum refiner with start up costs of $663,675 and ongoing costs of $311,915) and 230 smaller suppliers who are represented by company F (the small-medium manufacturer with start up costs of $281,757 and ongoing costs of $50,969).

While other options for covering petroleum suppliers exist (such as covering major liquid fuel suppliers only), these approaches could require a new framework for estimating supply and ensuring compliance. The compliance and administration costs of these approaches would be much greater than basing requirements on existing excise and customs duty arrangements. Moreover, this would not result in comprehensive coverage of petroleum fuel emissions.

In response to the Green Paper, stakeholders agreed that piggy backing on the excise and customs duty arrangements was the least costly and most efficient approach.

The one concern raised was in relation to the interaction of the excise and customs duty system with the Government’s planned cent for cent rebate and its implementation. Stakeholders, such as BP, the Energy Supply Association of Australia, the Australasian Railway Association and the Australian Shipowners Association, questioned the need to include petroleum in the scheme if the Government was planning to offset the effects of its inclusion. Compliance costs would be minimised by utilising the existing arrangements of the tax system to implement the cent for cent offset. This avoids setting up a new and potentially complex, expensive framework for a transitional measure.  The offset arrangements will be reviewed for heavy vehicles after one year and for households, on-road business users and agricultural and fishing industries after three years. Many fuel suppliers would have significant direct emissions from other activities (such as refining and industrial processes) and would need to be involved in the scheme to cover these emissions. As a result they will already need to set up the administrative and compliance arrangements associated with the scheme. Moreover, the administrative arrangements for permit acquittal will need to be in place following the end of the offset period anyway.

As a result it is still proposed to cover all fuel suppliers from the beginning of the scheme regardless of the cent for cent commitment. In the case of liquid fuels currently subject to excise and excise-equivalent duty, the preferred approach is to apply the scheme requirements on all excise and customs duty remitters.

Other fuel suppliers

Other fuel suppliers cover the supply of natural gas, coal, liquefied natural gas (LNG), compressed natural gas (CNG), and liquefied petroleum gas (LPG). These fuels are used by a wide range of large and small emitters in the stationary energy and transport sectors as well as being used as feedstock in the plastics and chemicals industries. For instance, LPG is a common alternative to petrol in the transport sector. Natural gas is used in the generation of electricity, in many industrial processes and domestically by households.

Comprehensive coverage of the emissions from these fuels can be achieved by covering all producers and importers. In most cases this would entail coverage of a relatively small number of entities. There are only around 14 suppliers of LPG, 30 natural gas producers and 6 suppliers of brown coal products (including five mines and one briquette supplier) and a number of these companies will be liable under the scheme for other reasons (that is they are also a mining company or petroleum refiner). Although, in the case of black coal, there are more than 200 coal mines, washeries and distributors. Most of these entities will be large emitters of greenhouse gases in their own right (direct emissions greater than 25 kt CO 2 -e/year) and will have to participate in the scheme in any case. As a result, the compliance costs associated with using these entities to report on fuel sales and surrender permits accordingly would not appear to be highly significant.

However, there are two significant drawbacks to covering all fuel at this point in the supply chain, particularly related to supply chains involving intermediaries between the supplier and the end user. Firstly, it would not allow large fuel users (with emissions exceeding 25 kt CO 2 -e/year) to manage their own liabilities under the scheme in situations where there is no contractual relationship between the supplier and the large user. Instead these entities could potentially face a higher fuel cost associated with the suppliers permit acquisition and liability management strategies. Large emitters are likely to find this approach sub-optimal as it removes from their control the ability to directly manage liabilities accrued under the scheme and these are likely to be significant liabilities for many entities. Secondly, the specific end use of a fuel cannot necessarily be determined by an upstream supplier and therefore accurate emissions estimation might not be possible. For example, in the case of LPG, the emissions resulting from LPG combusted as a transport fuel are different to the emissions resulting from LPG combusted for stationary energy.

To overcome these issues, an administrative mechanism could be established to enable scheme liabilities to be transferred from upstream producers and importers of fossil fuels to downstream entities (such as marketers, distributors and retailers).  Arrangements would be required to allow suppliers to ‘net out’ fuel sold to large emitters, fuel used as a feedstock and fuel that is not covered under the scheme (including fuel that is exported, fuel used in international shipping, fuels supplied to visiting defence forces), by providing the supplier of the fuel with an Obligation Transfer Number. This will allow marketers, distributors and retailers to take responsibility for scheme obligations for fuel sold to smaller users. Importantly it would also allow these large emitters to directly manage their scheme obligations including decisions relating to the timing and source of permit purchases, abatement opportunities and hedging choices. It is also important to note that this group of companies would include many of the largest emitters in Australia. Their involvement is seen as being critical to the development of the scheme.

This would imply that the fuel price paid by small users would include the cost of permits while the fuel cost paid by large users would not. An appropriate threshold would be 25 kt CO 2 -e/year as this is, for the most part, the threshold at which businesses are required to report emissions under the NGERS. Companies under this threshold would have no scheme requirements and as a result incur no compliance costs (though they would face higher fuel costs).

Netting out arrangements would result in additional compliance costs as a small additional number of companies are likely to be involved in the scheme, and because compliance with the scheme is now more complicated. Companies would be required to keep track of both fuel supplied inclusive of a carbon price as well as fuel supplied under an Obligation Transfer Number. In some cases, these compliance costs will be greater (for instance for a natural gas distributor supplying to a large number of small and large emitters) in other cases they are likely to be small (for instance for a coal mine supplying only a few large emitters).

In all, it is estimated that the compliance costs for companies affected by this option would be around $70 million (start up costs) and $41 million (annual ongoing costs). As discussed in box 3.2, this is based on 24 gas supply companies and 138 mining companies. Many of these companies will already be liable for their own emissions and additional costs associated with these ‘upstream’ activities will only represent a portion of these costs.

A number of intermediaries (marketers, distributors and retailers) supported their inclusion in the scheme as being a more appropriate point of obligation than further upstream. For instance the Australian LPG Association (LPGA) argued that:

To ensure that coverage is as close as possible to the point of end-use, and that costs and pass-through can be most efficiently managed, LPGA recommends that the primary point of obligation for LPG is by marketers

Similarly Shell Australia noted that:

Being able to identify the use of the LPG is important in determining emissions obligations under the CPRS

A more limited number of retailers (such as Energy Australia) considered that the obligation for surrendering permits for the use of gas by small users should apply to gas producers rather than to retailers. However, as discussed above, there are significant drawbacks to this approach as gas producers will often have incomplete information about the final use of the gas (and therefore the liability for permits).

In all, the preferred approach is for scheme obligations to apply to upstream fuel suppliers (including producers and importers) who would ‘net out’ sales to Obligation Transfer Number holders (including large emitters, marketers, distributors and retailers). While this approach has additional compliance costs, the ability of large emitters to directly participate in the scheme is crucial to the scheme. It is also beneficial to exclude the cost of carbon from fuel used as feedstock and fuel not covered by the scheme. The benefits of netting out (to individual companies and the scheme more generally) is judged to outweigh the additional compliance costs.

Fugitive emissions

Fugitive emissions account for around six per cent of Australia’s emissions. [24] Fugitive emissions are released in the course of oil and gas extraction and processing; through leaks and deliberate releases from gas pipelines; and as waste methane from black coal mining. Most fugitive emissions occur from facilities that emit more than 25 kt CO 2 -e/year (around 120 coal mines and fewer than 50 gas producers and distributors).

There are both national default emission factors and site-specific emissions estimation methodologies for fugitive emissions from oil and gas production.

At present, facilities that emit more then 25 kt CO 2 -e/year are already required to report emissions under the NGERS requirements. Including these facilities in the scheme would cover a significant portion of national emissions (with the attendant benefits of opening up opportunities for abatement and spreading the burden of emissions reductions more widely). Compliance costs of including fugitive emissions are estimated to be around $396,210 to $373,217 (start up) and $278,320 to $291,059 (ongoing) per business. Assuming 114 companies responsible for fugitive emissions, total compliance costs would be around $45 million (start up) and $32 million (ongoing). [25] It should be noted that most of these emitters will also have liabilities under the scheme as a result of being upstream suppliers of coal and gas products. It is estimated that there are 12 additional fugitive emitters which do not have liabilities elsewhere. The compliance costs for these companies alone is around $5 million (start up) and $3 million (ongoing) (this is included in the above estimate).

As with other scheme coverage considerations, the benefits of including fugitive emissions are that it expands abatement opportunities and reduces the overall costs of meeting any given scheme cap. Abatement opportunities in this area include the capture and use of coal seam methane for power generation or flaring to reduce emissions. For large emitters the benefits of expanded coverage are judged to outweigh the compliance costs associated with the inclusion of fugitive emissions.

A question remains as to whether and how to cover fugitive emitters who emit less than 25 kt CO 2 -e/year. It would appear that relatively few emissions originate from such emitters. As such, covering these sources would result in relatively few opportunities to abate and would impose additional compliance costs on these emitters (as they have no obligations under the NGERS). While there is the possibility that excluding these emitters from the scheme would introduce distortions between covered facilities and facilities below the threshold, those distortions, if they occur, are likely to affect relatively few facilities.

Few stakeholders commented on the proposed inclusion of fugitive emissions in the scheme. Those who did, including the Australian Coal Association, Xstrata and Rio Tinto, focussed on the inclusion of open cut coal mines in the scheme. Emissions from open cut coal mines are variable with some emitters falling below the level implied by the internationally agreed default factor and some falling above it. As such, using the default factor would result in benefits to some producers (from underestimation of emissions) and costs to other users. Fugitive emissions from open cut coal mines can also be estimated using a site specific methodology. Companies with emissions above the default average could benefit from using this method. While fugitive emissions, or more specifically fugitive emissions from coal mines, could be removed from the scheme until more accurate methodologies are adopted across the industry, this would remove a significant portion of emissions from the scheme and impose costs on other covered entities. It may also act as a disincentive to adopt more accurate methodologies for measuring fugitive emissions from open cut coal mines.

The preferred approach is to include fugitive emissions from facilities with emissions greater than 25 kt CO 2 -e/year from all sources.  Facilities with fugitive emissions, but with less than 25 kt CO 2 -e/year from all sources, would not be included in the scheme.

Industrial processes

Industrial process emissions account for around five per cent of Australia’s emissions. [26] These emissions are from chemical reactions (other than fuel combustion) and include emissions resulting from consumption of synthetic greenhouse gases—hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur hexafluoride (SF 6 ). Emissions from synthetic greenhouse gases are dealt with separately below.

There are internationally approved, site-specific methodologies for estimating most of these emissions.

The largest individual sources of industrial process emissions are iron and steel making, cement and lime making and aluminium smelting. Facilities that emit more than 25 kt CO 2 -e/year account for the great majority of industrial process emissions (other than synthetic greenhouse gases). These facilities already have obligations to report under the NGERS regime. Moreover, most industrial processors will have significant stationary energy emissions and will need to participate in the scheme to cover these emissions. As a result, the additional compliance costs associated with covering industrial processes are expected to be minimal.

Stakeholders raised no objection to the inclusion of industrial processes in the scheme and coverage of this sector is the preferred option.

Synthetic greenhouse gases

Synthetic greenhouse gas emissions account for around one per cent of Australia’s emissions (or around one-fifth of industrial process emissions). [27] These emissions are from the use of commercial and household equipment such as refrigeration, air-conditioning and high-voltage electrical equipment.

As with other sectors and industries, the inclusion of synthetic greenhouse gases would increase the coverage of the scheme, spreading the burden of emissions reductions and introducing additional abatement opportunities.

Emissions of synthetic greenhouse gases are widely distributed (for instance amongst refrigerator units and fire fighting equipment). As a result few emitters have to report under the NGERS scheme and it would be implausible to cover individual emitters under the scheme. The only feasible avenue for covering synthetic greenhouse gases under the scheme would be to require importers and manufacturers of such gases to surrender permits to cover the eventual emissions of the gases they introduce into Australia. Synthetic greenhouse gases are supplied either in bulk or in equipment such as white goods and air-conditioners. As a result the key liable parties are likely to be specialist synthetic gas importers and domestic synthetic greenhouse gas manufacturers (of which there currently are none). It is expected that no small businesses will be liable under the scheme after the application of the 25 kt CO 2 -e/year threshold discussed below.

Virtually all importers and manufacturers of synthetic greenhouse gases already have to report volumes of gases imported under the Ozone Protection and Synthetic Greenhouse Gas Management Act 1989 and this should reduce compliance costs associated with the scheme. Nevertheless, r equiring importers and manufacturers to acquire and surrender permits under the scheme would impose some additional compliance costs. It is estimated that the compliance costs would be around $328,700 (start up) and $67,271 (ongoing) per business.

Importers and manufacturers of SF 6 do not currently have reporting obligations, although a subset of SF 6 importers have reporting obligations for other synthetic greenhouse gases they import. For SF 6 importers and manufacturers without a current reporting obligation there will be additional compliance costs relating to reporting but as noted in the RIS for the Ozone Protection and Synthetic Greenhouse Gas Management Legislation Amendment Bill 2003, these costs are minimal.

While the compliance costs for synthetic gas importers and manufacturers are lower than for other companies, it may still not be worth requiring all to be covered by the scheme. There are a (relatively) large number of companies who import a very small amount of synthetic greenhouse gases. For instance, imposing a threshold of 25 kt CO 2 -e/year would remove most importers from the scheme while still ensuring that the scheme covered 95 per cent of emissions from synthetic greenhouse gases. A 25 kt CO 2 -e/year threshold would capture approximately 45 companies with compliance costs of around $15 million (start up) and $3 million (ongoing) (see box 3.2).

In general stakeholders recognised the need to include synthetic greenhouse gases in the scheme. However, some stakeholders, in particular bulk importers of synthetic greenhouse gases, objected to being covered by the scheme. They were concerned about the cash flow implications resulting from the imposition of scheme obligations. Synthetic greenhouse gases have significant global warming potential and as a result will require a significant number of permits per ton of emissions. While only small amounts are imported (relative to the emissions of other gases), the scheme may still have a significant impact on the price of such gases. Stakeholders, such as Refrigerants Australia, A Gas, Arkema, Actrol, VASA, AREMA , DuPont, were concerned that they may suffer losses as a result of this price increase. It is difficult to see why stakeholders would suffer a significant loss in this manner. They will be able to (and expected to) pass on the costs of coverage, eventually to consumers. Any risks from the differing timing of liabilities under the scheme and revenue from costs passed on can be addressed through the purchase of permits on an ongoing basis (either from Government auctions or the secondary market). They could even purchase permits ahead of time, which would give certainty regarding the costs of permits.

In all, the preferred option is to include synthetic greenhouse gases in the scheme by imposing requirements to acquire and surrender permits on importers of synthetic greenhouse gases and domestic synthetic greenhouse gas manufacturers (of which there are currently none). A threshold of 25 kt CO 2 -e/year would apply to ensure that compliance costs are not imposed on small importers and manufacturers whose inclusion in the scheme would not be cost-effective.

There are three issues that pertain to the implementation of the scheme for synthetic greenhouse gases.

The first issue concerns importers and manufacturers of synthetic greenhouse gases that import or manufacture less than 25 kt CO 2 -e/year of these gases.  While it would not be cost-effective for these smaller entities to participate in the Scheme, as scheme compliance costs would be considerably higher for these smaller entities than for other scheme participants, excluding them from the Scheme would create competitive distortions.  The Airconditioning and Refrigeration Equipment Manufacturers Association noted that ‘the introduction of a threshold is fraught with danger, given the market distortions this entails. The introduction of a threshold can also lead to the development of artificial business restructuring and other artificial strategies to allow firms to come in under the threshold.’

Distortions could be significant for importers and manufacturers of bulk synthetic greenhouse gases because the cost of permits will generally be greater than the market price for the synthetic greenhouse gas. Distortions could also arise between importers and manufacturers of synthetic greenhouse gases in equipment, particularly where the permit value of the synthetic greenhouse gas contained within the equipment is high compared to overall price of the product. Measures will therefore be developed to remove the potential for market distortions resulting from the application of a 25 kt CO 2 -e/year threshold in this sector.

The second is in relation to synthetic greenhouse gases which are not captured under the Kyoto definition of greenhouse gases but are covered under the Montreal Protocol - the hydrochlorofluorocarbons (HCFCs). These gases are substitutes for covered gases and contribute to both climate change and depletion of the ozone layer. The exclusion of these gases from the scheme could result in substitution (and carbon leakage) to non covered synthetic greenhouse gases.

A ban on the import and domestic manufacture of HCFC containing equipment would be consistent with measures implemented in the US, Europe and Japan and has the advantage of reducing Australia’s reliance on HCFCs in the lead up to the complete phase out of HCFCs. However, this will not remove competitive distortions where entities operating existing HCFC equipment compete with entities using HFCs. As suggested by Refrigerants Australia, ‘There will be an incentive to stay with HCFC equipment, rather than convert to HFCs’.

To minimise the potential for perverse outcomes for Australia’s ozone protection program, the import and domestic manufacture of HCFC containing equipment will be prohibited from scheme commencement. In conjunction with this measure, additional measures will be developed to minimise competitive distortions that might otherwise arise between HCFCs and gases covered under the scheme.

The third issue pertains to the treatment of gases which are destroyed. As destroyed gases are not released into the atmosphere, there would be no reason to include them in the scheme. However it is impossible, at the stage of importation or manufacture, to determine which gases will eventually be destroyed (so consideration at that point is infeasible). To ensure that proper credit is given for the destruction of synthetic greenhouse gases (and the appropriate incentive for their destruction is maintained), entities will receive scheme permits for gases destroyed in accordance with scheme requirements for verification.

Waste

The waste sector accounts for just over three per cent of Australia’s emissions. [28] Around 80 per cent of waste sector emissions are from solid waste to landfill, with the remainder from wastewater (around 20 per cent) and solvent and clinical waste incineration (less than one per cent). The sector is not restricted to dedicated waste facilities — wastewater from some manufacturing processes is treated on-site at the manufacturing plant.

There are around 450 active solid-waste handling sites in Australia and well over 300 wastewater sites. However, most waste volume is managed by larger sites. In the case of landfill, fewer than 100 sites (around 20 per cent) account for more than 80 per cent of waste volume. [29]   These sites are operated by a mixture of local governments and corporate service providers. Similarly, around 80 per cent of wastewater sites are small facilities, servicing rural and regional communities.

The waste sector presents a number of opportunities for cost effective abatement. Indeed some of these are already being pursued. For example, methane capture is common in the solid waste and wastewater sectors. An estimated 26 per cent of methane emissions from landfill sites is either flared or used to generate renewable energy. [30] In addition, inclusion of waste sector emissions could be expected to reduce the amount of waste sent to landfill and encourage alternative waste technologies. In general, including the waste sector in the scheme is likely to lower overall abatement costs and provide significant benefits.

At present, waste sector emissions are covered under the NGERS reporting system, so waste sector facilities that meet NGERS participation thresholds are already required to have measurement and reporting procedures in place. Waste sites generated by local governments are not covered under NGERS, however calculation of emissions can be estimated using a default factor. The additional compliance costs associated with scheme participation are estimated to be around $353,061 (start up) and $58,305 (annual ongoing) per business.

Most stakeholders indicated in-principle support for waste sector coverage, but many had serious concerns relating to the accuracy of measurement protocols.

By their nature, fugitive emissions — which are generally released in an uncontrolled manner — are more difficult to estimate than other emissions sources. Technology for directly measuring waste sector emissions is in its infancy. Emissions vary across most landfill sites and it can be difficult to obtain an accurate reading of the overall emissions. Nevertheless, efforts are being made to develop more effective measures of emissions from landfill sites. These are being driven by increased Government regulation of greenhouse gas emissions and by a growing commercial interest in landfill gas capture for energy generation. While these techniques are being developed, estimates of emissions can be made based on proxies such as the volume of waste deposited.

Stakeholders were also concerned about the treatment of emissions generated from historic waste streams (also known as legacy emissions). Landfill sites continue to emit greenhouse gases for decades after their closure. If scheme requirements are imposed on sites that are close to closure (or indeed already closed) there are limited opportunities for owners of these sites to recover costs from ‘gate fees’. While this issue is significant, for operators of sites close to closure there are some options open:

•        In many cases, they have contracts with local Governments which could be renegotiated to cover costs.

•        They can engage methane capture technology to greatly reduce emissions from these sites.

•        They can apply for assistance through the Government’s Climate Change Action Fund.

For sites that are already closed, passing on costs directly is infeasible. In addition, there are a large number (possibly thousands) of small, closed sites scattered throughout Australia. Many now have alternative uses. While most of these sites could be expected to fall below participation thresholds, the costs of identifying them and assessing their participation status could be significant. The preferred position is to exclude from the scheme sites that are already closed.

If the waste sector is covered by the scheme, an appropriate participation threshold needs to be developed. For the solid waste sector, a departure from the 25 kt CO 2 -e per year threshold proposed for other sectors may be warranted. In contrast to the treatment of energy-related emissions, sub-threshold waste facilities will not face a carbon price in any from, either directly or indirectly. This raises potential competitive distortions between covered and uncovered sites, particularly in highly competitive markets. Failure to cover sub-threshold facilities also introduces the potential for waste to be displaced from covered to uncovered sites to avoid permit obligations. In light of these concerns, stakeholders generally supported a threshold of 10 kt CO 2 -e per year, or lower, in urban areas, with highly competitive markets.

However, extending the 10 kt CO 2 -e per year to non urban areas has some drawbacks. Small, council-run sites — many of which sit around a 10 kt threshold — have expressed the view that there is limited capacity to absorb participation costs as it would involve increasing rates. However Hyder consulting [31] advised that:

Local government regulations typically permit genuine cost recovery within rate setting and waste management contracts are generally flexible enough to allow for any increased costs to be passed on to councils. …

… councils can generally pass on any additional waste management costs to the rate payers after a community consultation process. In the majority of, if not all, cases this takes place towards the end of the financial year while the new rates become effective with the new year.

Key stakeholders from State Governments and local councils noted that a 10 kt CO 2 -e/year threshold could discourage consolidation of the many small landfill sites in rural and regional Australia. As a result of these concerns, stakeholders preferred the retention of the 25 kt CO 2 -e /year threshold for non-competitive markets. The reduction in coverage associated with this limit is not expected to be significant.

In all it is estimated that  hybrid 25 kt CO 2 -e/year and 10 kt CO 2 -e/year threshold will capture around 200 facilities (assumed to be operated by 120 companies — see box 2.2). This would imply compliance costs of around $42 million (start up) and $7 million (annual ongoing).

The preferred approach is to include the waste sector in the carbon pollution reduction scheme. While there are additional compliance costs and some difficulties with sites close to closure, these are not insurmountable and the advantages of expanded coverage that the sector offers are judged to outweigh these costs.

The preferred participation thresholds for landfill operators are 25 kt CO 2 -e/year in non-competitive markets and 10 kt CO 2 -e/year in competitive markets. Consistent with broader scheme design, a 25 kt CO 2 -e/year participation threshold will be retained for all other waste sector facilities.

Given the problems associated with the coverage of legacy emissions, one implementation option is to exclude legacy emissions from the scheme until 2018. After that time, legacy emissions would be reduced on average by around 45 per cent. This would reduce the financial impact of legacy emissions and give landfill operators time to install methane capture technology to minimise their emissions profile.

Emissions from land use

The Government has indicated that coverage of the Carbon Pollution Reduction Scheme would be limited to domestic sources and sinks that count towards Australia’s international obligations (see box 3.4 for further detail on international accounting rules).

Box 3.4: Current international accounting

The international accounting rules, as applied under the Kyoto Protocol, are relevant to the design of the scheme because they determine which emissions sources and sinks count towards Australia’s international commitments. Importantly, Kyoto Protocol accounting rules for land based emissions are not comprehensive; they cover a limited set of emissions sources and sinks. These sources are as follows:

•        Agriculture emissions (contained within Article 3.1 of the Kyoto Protocol) includes enteric fermentation in livestock, manure management, rice cultivation, agricultural soils, prescribed burning of savannas, and field burning of agricultural residues.

•        Emissions from land use change and forestry (Article 3.3 of the Kyoto Protocol) which includes net emissions from forests established since 1990 on land that was clear of forests on 31 December 1989, and deforestation.

Article 3.4 of the Kyoto Protocol provides for additional activities that countries may elect to count toward their emissions target during the first commitment period. These elective activities are:

•        Forest management (plantation forests established before 1990 and all native forests under some form of management)

•        Revegetation (establishment of woody biomass that does not meet forest criteria)

•        Grazing land management (carbon stored in soil and vegetation on grazing land)

•        Cropland management (carbon stored in soil and crops)

•        If a country chooses to include any of the additional activities, it must also include and report on, all emissions from all land nationwide on which those activities are undertaken. Australia has elected not to include these activities because of the high risk that drought or bushfire could result in significant emissions from these sources during the first commitment period.

Agriculture

Agricultural emissions make up approximately 16 per cent of Australia’s emissions. Agriculture is the dominant source of methane (primarily from livestock) and nitrous oxide (mainly from agricultural soils) emissions. The agricultural industry is dominated by a large number of small businesses. Very few farm businesses would meet the 25 kt CO 2 -e/year threshold for reporting under the NGERS requirements.

As such, the inclusion of agriculture would have significant benefits. As with other sectors, its inclusion would broaden the base of the scheme and introduce additional abatement opportunities. This would reduce the overall costs of achieving a specified scheme cap under the scheme.

However, there are also a number of difficulties with including agriculture in the scheme.

The measurement of agricultural emissions is difficult. Agricultural emissions are highly variable in response to management practices and climatic conditions. For example, cattle breeds and feed types in tropical and subtropical regions differ from those in temperate regions, and have methane conversion rates that are significantly different. Nitrous oxide emissions from soils in major cereal-growing regions vary geographically and over time, according to different rainfall, soil types and fertiliser application rates. As a result indirect measurement options (using proxies such as livestock numbers or cropping areas) are imprecise and may lead to inequitable outcomes.

In addition, the sector includes more than 100,000 entities, many of which emit less than one kt CO 2 -e/year. Even if a threshold for agricultural emissions coverage is applied the number of liable entities would still be significant. For example, covering about 80 per cent of direct emissions from the beef, sheep, dairy and wheat industries would require participation in the scheme of around 45,000 farm businesses.

In other areas, such as transport, where there are a large number of emitters the preferred approach has been to capture these emissions by placing obligations on upstream (or downstream) producers. In the case of agriculture this would imply placing obligations on facilities such as abattoirs and fertiliser suppliers. However, such an approach would be difficult because:

•        there would still be a significant number of responsible entities who would have to participate in the scheme; and

•        the difficulties in indirect measurement mean that indirect coverage of emissions is likely to be inaccurate and potentially inequitable.

The Government’s preferred position as outlined in the Green Paper was that agriculture would not be included in the scheme from commencement but that a decision as to whether agriculture would be covered in 2015 would be made in 2013.

Agriculture stakeholders generally agreed with the Government’s assessment that coverage of agriculture emissions will not be possible from scheme commencement. Many stakeholders argued for the adoption of complementary measures (for example, financial incentives for adoption of best management practices) to encourage emissions reductions prior to scheme commencement or as alternative to coverage over the longer term. However, stakeholders outside the agriculture sector supported inclusion of the agriculture sector at the soonest opportunity noting that this will reduce the overall costs of achieving Australia’s mitigation targets and hence the burden on other sectors of the economy. 

Agriculture stakeholders were generally of the view that current international accounting rules did not present an accurate picture of emissions from land-use. For example, the National Farmers Federation argued that:

international greenhouse accounting rules for the land-based sectors do not appropriately acknowledge the full sequestration function of agricultural production systems. These accounting rules do reflect Australia's obligation under the Kyoto Protocol but are not appropriate for the longer term goals of Australia's CPRS and are adding to misleading interpretations of agriculture's contribution to global warming.

Stakeholders encouraged the Government to negotiate changes to international rules or to implement a domestic scheme that is not consistent with the Kyoto Protocol but instead based on optimal accounting rules.

The Government will continue to work towards international accounting rules that are scientifically based and suited to Australia’s particular circumstances. However, coverage of agriculture emissions will not be contingent on achieving an optimal international accounting framework. The outcome of international negotiations can not be predicted. 

Overall, the preferred position is that agriculture not be included in the scheme from commencement. Current measurement difficulties and the large number of potentially liable entities mean that the compliance costs associated with the inclusion of agriculture would be substantial and are likely to outweigh the benefits associated of expanded coverage. To support a final decision on the potential coverage of agriculture, the Government will work with industry to identify cost effective points of obligation in the supply chain, the scope for incorporating direct farm level management of emissions and necessary improvements in emissions estimation methods and development of efficient administrative systems.

Reforestation

Reforestation would differ from other covered activities because it will often provide a net carbon sink. Therefore, whereas other covered entities would be required to surrender permits for their emissions, forest landholders are likely to receive permits for increases in net sequestration.

The inclusion of reforestation provides additional opportunities for abatement measures within the scheme. This would reduce the overall costs of abatement and would reduce the burden imposed on other sectors by the scheme.



The compliance costs associated with the inclusion of forestry would depend on how the sector was included. (There are no current reporting obligations for the forestry industry, so all scheme obligations would be ‘new’.) There are two options for including reforestation:

•        mandatory coverage

•        voluntary ‘opt in’.

The mandatory coverage option would entail significant compliance costs. It would cover all entities managing forests and would require a large number of small forest holders to meet scheme obligations. In many cases these entities would have small holdings with limited carbon captured or emitted. As a result, mandatory inclusion would entail significant compliance costs and in some cases these costs could outweigh any potential benefit from inclusion in the scheme.

When considering reforestation, a voluntary ‘opt in’ arrangement is preferred because scheme participation would not be beneficial for all. Benefits of scheme participation are likely to be determined by expected future carbon price, forest management regime and scheme design details including compliance costs. Forest owners who opt in to the scheme will consider these factors when deciding whether to opt in to the scheme.

In determining scheme design, there is scope to reduce compliance costs, for example, by tailoring reporting and crediting requirements.

In other sectors, scheme liabilities are calculated based on a liable entity’s annual emissions report. Forest owners could also be required to report annually. However, forests are likely to be net carbon sinks, and therefore eligible to receive permits rather than required to surrender permits. For this reason, it may be possible to implement alternative, less onerous reporting arrangements.

To minimise costs for growers, and ensure that changes in forest sequestration are adequately reported, forest growers will be required to provide sequestration reports at the end of each commitment period or at least once every five years, which ever comes sooner. As permits will only be issued following receipt of a sequestration report the Government will also allow forest growers to elect to report more frequently but no more than once a year. Forest growers would also be required to report on any significant management or disturbance events that might change projected forest sequestration.

In implementing the scheme, there is a risk that if the government provides ‘full annual crediting’ [32] of permits for all net increases in greenhouse gases stored in the forest, forest owners will incur significant liabilities when they harvest the forest or if it is destroyed by fire (as they will have to surrender permits to cover the emissions from the forest). In extreme cases this may lead liable entities to default on their surrender obligations and the Government would become liable for the emission resulting from the loss of the forest. As a result, in implementing the scheme it is proposed to use an ‘average crediting’ system where growers will receive a maximum number of permits which is equal to the long term average increase in net greenhouse gas removals (taking into account the risk of fire). Under most circumstances, growers will not be required to surrender permits unless they permanently retire the forest (that is, use the land for an alternative purpose).

In general, forest industry stakeholders supported the Government’s proposed approach to reforestation but have some concerns in relation to the design detail of coverage — many stakeholders expressed misgivings about the complexity and project-level accuracy of the current National Carbon Accounting Toolbox (NCAT) for estimating emissions and removals.  Other stakeholders suggested that the NCAT did not accurately reflect the carbon sequestered in certain forest types, for example biodiverse plantings. The Government will continue to update NCAT’s user interface and will develop protocols outlining the procedures for incorporating external data into NCAT where this information can be verified as accurate.

Submissions from the agricultural industries expressed concern about the potential implications of coverage of reforestation for land and water use. Agriculture industries were particularly concerned that the scheme could provide an incentive for an increase in managed investment scheme forestry, affect water availability, or provide incentives for the conversion of prime agricultural land to forestry.

Allowing entities to accrue carbon permits for reforestation will provide an incentive for land use change. In some cases this would be at the expense of existing industries (predominantly agriculture). In other cases, it may make use of degraded or more marginal lands. In some cases, the forest may also provide environmental benefits other than carbon sequestration, for example, reduced salinity and soil erosion or assisting biodiversity conservation. Increased forestry activity may also have implications for water use as forests typically use more water than other land uses. This may be accounted for if forest owners are required to purchase the water intercepted by plantations (that is purchase the water that would otherwise have flowed to downstream users). From a community wide perspective it is difficult to assess whether these land and water use impacts, when taken together, are positive or negative.

Submissions from some conservation groups expressed concern that the inclusion of reforestation but not deforestation in the scheme could lead to increased deforestation. Conservation groups believe this could occur if forest growers have the incentive to maintain forests planted after 1990 for carbon purposes rather than harvest them. Under this scenario, demand for wood products would be met by increased harvesting of native forests. In many Australian States the management of native forests is regulated by Regional Forest Agreements (RFAs) which are twenty year plans for the conservation and sustainable management of Australia’s native forests. In addition, forests that are eligible for the scheme may be subject to contractual or tax arrangements that require their harvest. The Government considers that these factors are likely to limit any increase in deforestation as a result of coverage of reforestation.

Overall, the preferred approach is to include forestry in the scheme on an ‘opt in’ basis.

In implementing this position, rules will be needed to ensure that forest owners are likely to be able to meet their long term permit obligations. Forest owners are likely to build up a long term liability in terms of carbon permits that would need to be surrendered if the forest was converted to an alternative non-forest land use. The Government will limit scheme participation to entities that have met accreditation criteria and include under the scheme a range of enforcement provision to ensure that forest owners meet these obligations.

Deforestation

Deforestation accounts for a significant (though declining) portion of Australia’s greenhouse gas emissions. In 2006 it accounted for around 11 per cent of Australia’s emissions.

As such, including deforestation would significantly expand coverage of the Carbon Pollution Reduction Scheme, provide cost effective abatement options and reduce the overall costs of achieving any given scheme cap.

However, there would also be a number of costs:

•        The areas cleared annually on individual landholdings range from less than one hectare to thousands of hectares. Depending on the thresholds for inclusion in the scheme, covering deforestation could create thousands of potentially liable entities and there are no obvious points of obligation elsewhere in the supply chain.

•        The need for thresholds to contain scheme costs would mean that a significant proportion of deforestation would not be covered.

•        Monitoring, reporting and compliance arrangements would be complicated by the periodic nature of deforestation. Unlike emissions from industrial facilities, the timing of emissions from deforestation is difficult to predict.

•        Announcing plans to include emissions from deforestation in the scheme would also create powerful incentives for pre-emptive land clearing (where allowed under state and territory regulations) in order to avoid a future obligation. This could have a range of negative environmental consequences, as well as increasing emissions in the Kyoto Protocol period.

It is also important to note that there are a number of state restrictions on the clearing of ‘remnant’ or mature forests which have reduced, and are likely to continue to reduce, emissions from deforestation.

Some conservation groups advocated the inclusion of deforestation in the scheme. Conservation groups also advocated the strengthening of existing state land clearing legislation and other complementary measures such as incentive based approaches or structural adjustment programs to achieve further emission reductions from the sector. Many of these stakeholders noted that accounting for the land use sector was incomplete and suggested that forest management including forest degradation be recognised in the scheme. For instance, the Australian Conservation Foundation recommended that:

Australia moves to a system of full carbon accounting for all forestry as soon as possible. The polluter pays principle should apply to all forestry and deforestation emissions. This could be applied through the payment of a carbon tax or through coverage under the CPRS once accounting is sufficient.

The Humane Society International advocated the inclusion of deforestation on a voluntary opt in basis. However, the administration arrangements for deforestation are likely to be significantly more complex than for reforestation.

The circumstances in which landholders are able to obtain a land clearing permit vary from state to state. Such an approach could create perverse incentives for landowners to apply for land clearing permits when they would not otherwise have done so. Further, some land managers may have only a conditional right to clear land in limited circumstances. Conditional rights could not be recognised for the purpose of crediting avoided deforestation. 

While there are considerable benefits from the inclusion of deforestation in the scheme, there are also considerable costs. On balance, the risks of excessive deforestation prior to the scheme and the difficulties associated with administering the scheme in relation to deforestation are judged to outweigh the benefits. The preferred approach is that emissions from deforestation would not be included in the Carbon Pollution Reduction Scheme.

Offsets

The scheme could allow non-covered entities to undertake projects that would reduce emissions from ‘business as usual’ levels and grant permits for this abatement (that is to offset emissions in covered sectors). Allowing offsets would create incentives to reduce emissions from uncovered activities, and lower carbon costs within the scheme by giving liable entities access to a broader range of abatement opportunities.

Offsets can only come from emissions sources that are outside the scheme. The very broad sectoral coverage proposed for the scheme means that there is inherently less scope to pursue offset activities. Nevertheless some emission sources are likely to remain outside the scheme, for example, deforestation and savanna burning. In addition some emissions sources such as agriculture are unlikely to be included in the scheme from commencement.

Some stakeholders considered that offsets should be allowed in the scheme, for example, from soil carbon, biochar and deforestation. The difficulty with allowing offsets within the scheme is that they are inherently complex to establish and administer. The regulator must be sure that additional abatement has occurred (that would not have occurred in the absence of the offset scheme) and the abatement is permanent. As a result offset schemes have high compliance and administration costs.

Moreover, if agriculture is included in the scheme in the medium term future, there would be little time for an offset scheme for this sector to be established and deliver abatement prior to inclusion in the scheme. As a result it is the preferred position that the offsets would not be included in the scheme from commencement. This position would be reviewed following final decisions on the inclusion of agriculture.



4)      Reporting and compliance

Integral to introducing an emissions trading scheme is the measurement of emissions for each liable emitter. These measurements form the basis of reporting to the regulator and the eventual surrender of permits to cover emissions. For many emitters, the requirement to measure emissions will not be new. As discussed in chapter 3, emitters in most sectors already have the obligation to report emissions under the National Greenhouse and Energy Reporting System (NGERS).

The Government will also have to ensure compliance with reporting requirements. The operation of the emissions trading scheme will be new to all market operators and the need to surrender permits will impose significant costs on many emitters.  This may present motive and opportunities for either violation or inadvertent breeches of scheme requirements.

Existing NGERS requirements

A logical starting place when considering the most appropriate reporting requirements is to consider the existing obligations on business. Under NGERS, liable entities are responsible for reporting their total emissions of the six key greenhouse gases each year. The scheme was established to provide a national framework for reporting of emissions (prior to NGERS a number of different schemes required the reporting of emissions). It was also intended to form the basis for reporting under an emissions trading scheme and provides detailed information to help support Australia’s emissions reporting under the Kyoto Protocol. 

The NGERS reporting requirements apply to all facilities that cause emissions of greenhouse gases that have a CO 2 -e of 25 kt or more per year. As discussed in chapter 3, this covers the majority of emitters who will be caught under the emissions trading scheme. The additional compliance costs for those entities which are not required to report under NGERS are outlined in chapter 2 and detailed in Attachment B.

Under NGERS, the majority of emitters have the choice of four different methods for estimating emissions (see box 4.1). These include the National Greenhouse Accounts default method (Method 1) and higher order methods, (Methods 2-4). In moving through the methods from one to four, generally the estimation techniques become more accurate but also more expensive to comply with. That said, even the simplest method (Method 1) provides estimates using national averages and ensures accuracy at a nation-wide level.

Box 4.1:  Classes of methodologies available for NGERS

Method 1:  the National Greenhouse Accounts default method

Method 1 provides a class of estimation procedures derived directly from the methodologies used by the Department of Climate Change when preparing the National Greenhouse Accounts. The use of methodologies from the National Accounts anchors Method 1 within the international guidelines adopted by the United Nations Framework Convention on Climate Change for the estimation of greenhouse emissions.

Method 1 specifies the use of designated emission factors in the estimation of emissions. These emission factors are national average factors determined by the Department of Climate Change using the Australian Greenhouse Emissions Information System. For example the actual emissions content of coal will vary across facilities and locations, but a national average emissions factor is provided.

Method 2:  a facility-specific method using industry sampling and listed Australian or international standards or equivalent for analysing fuels and raw materials

Method 2 enables entities to undertake additional measurements — for example, the qualities of fuels consumed at a particular facility — in order to gain more accurate estimates for emissions for that particular facility. This method draws on the large body of Australian and international documentary standards prepared by standards organisations to provide benchmarks for procedures for analysing the properties of fuels being combusted.

Method 3: a facility-specific method using Australian or international standards or equivalent for sampling and analysing fuels and raw materials

Method 3 is very similar to Method 2, except that it requires reporters to comply with Australian or equivalent documentary standards for sampling of fuels or raw materials (as opposed to simply measuring) and documentary standards for analysing fuels.

Method 4:  direct monitoring of emission systems, on either a continuous or periodic basis

Method 4 provides for a different approach to the estimation of emissions. Rather than analysing the chemical properties of inputs (or, in some cases, products), Method 4 aims to directly monitor greenhouse emissions arising from an activity. This approach can provide a higher level of accuracy depending on the type of emission process, however it is more data-intensive than other approaches.

As for Methods 2 and 3, a substantial body of documented procedures on monitoring practices and state and territory government regulatory experience provides the principal source of guidance for the establishment of the system proposed under Method 4.

Options

There are two feasible options for establishing reporting requirements under the emissions trading scheme. The first is use the reporting requirements as set out under NGERS including the default Method 1 and higher order methods in specific circumstances. The second is to modify these requirements in areas where more detailed reporting is already current practice.

The first option would be the simplest to administer. It would give greatest flexibility to business and would minimise compliance costs — it would impose no new compliance costs on those captured by NGERS and would involve the minimum necessary compliance costs for those new to reporting.

In terms of accuracy, it does have some draw backs. It is likely that estimated emissions will depend to some extent on the method used to estimate emissions. This may lead some companies to choose the method of estimation that reports the lowest level of emissions. This could result in overall underestimation of emissions if only those who have lower reported emissions under the more accurate methods (methods 2 to 4) choose these options. This is not considered to be a significant problem as the more specific measurement methods are likely to be more costly to implement and these compliance costs would reduce the incentive to ‘shop’ amongst methods. Moreover, the difference in likely reported emissions between methods is unlikely to be significant for most emitters.

Nevertheless, there is scope to require the more accurate methods where these are already in common use in the industry (option 2). Requiring emitters to use the more accurate methods is desirable as it ensures each facility faces carbon costs that most accurately represent their specific emissions profile. In addition to fairness arguments, this is likely to reveal more abatement opportunities as operators will have a more detailed understanding of a facility’s emissions. Clearly, requiring more detailed measurement by all industries would impose significant compliance costs. Nevertheless, in some industries it is common practice to use the higher order methodologies. Three such industries have been identified:

•        As a result of NGERS and the Federal Government’s Generator Efficiency Standards program requirements, it is widespread practice in the electricity generation sector for large emitters to use one of the higher order methods (Methods 2 to 4)

•        It is widespread business practice for perfluorocarbon emissions from aluminium producers to be estimated using site specific methodologies

•        Underground coal mines are required to monitor emissions using higher order methods to meet state safety regulations.

Requiring these industries to use higher order estimation methods would impose minimal additional compliance costs and would ensure that future reporting continues to be accurate at a facility specific level.

Stakeholders provided limited comment in response to the Green Paper on the choice of measurement options. Stakeholders that did comment on these options generally supported using NGERS as a starting point and recognised the benefits to the scheme of pursuing staged increases in the facility level accuracy of emissions reports (including Exxon Mobil and ESAA)

The preferred approach is to use the NGERS reporting requirements except for the specified industries where more specific methods are common practice.

Implementation of the NGERS approach

Following the introduction of the emission trading scheme the regulator would monitor reporting practices (and choices of methods) of different industries. The intention would be to move industries to higher order methods as these become common business practice. A key consideration in these decisions would be the minimisation of compliance costs for reporting entities.

International standards change from time to time reflecting improvements in measurement methodologies and technological changes. The regulator will also have to monitor changes in international measurement standards and ensure that Australian standards reflect these changes. Applying these changes in the Australian context will require working closely with industry to ensure that adequate warning of impending changes and appropriate industry understanding of the new methodologies.

It is also likely that the implementation of the reporting requirements will require rules to prevent repeated switching between methodologies. While switching is desirable to allow emitters to choose their method of reporting, repeated switching could give rise to differences in reported emissions that do not reflect differences in underlying emissions. Moreover, businesses may alter their method from year to year to adopt whichever method is likely to give them the lower reported emissions in that year. This would not be in keeping with the intention of giving choice (to minimise compliance costs) and would create instability (and potentially underreporting) in total reported emissions. Therefore where an entity has elected to use Method 2 or above, for a particular source, that methodology would be the minimum standard for that entity for a period of four years. The scheme regulator may grant exceptions to this rule in some circumstances.

Documentation and record keeping requirements for emitters would be as required by the NGERS scheme with an amendment to the NGERS legislation so that the requirement to keep records is for five years. Reporting obligations would also be as set out under NGERS — emitters would report emissions using the Government’s Online System for Comprehensive Activity Reporting (OSCAR) by 31 October each year. The Government will also consider the need to move reporting of emissions to more frequently than on an annual basis following the commencement of the scheme.

Ensuring compliance with reporting requirements.

Under the proposed reporting requirements liable entities will report on their own emissions. As they will also have to acquire (buy) permits to cover these emissions, they will have an incentive to underreport their emissions.  There is also the risk that errors would be made in reporting either through negligence or through other ‘good faith’ mistakes. Errors in the reporting of emissions would have a number of negative consequences.

It is to be expected that most (intentional) misreporting would result in an underestimation of emissions and less permits being surrendered to Government. This would have implications for the accuracy of national emissions estimates and would represent an effective loosening of the cap.

Errors in reporting would also have significant implications for the credibility of the scheme. If there was a perception of widespread non-compliance, community support for the scheme would be much harder to maintain (in the absence of community acceptance and support, the long term future of the scheme could be called into question). At an international level, confidence in the legitimacy of the emissions reductions driven by the scheme is a key consideration in whether other countries will be willing to ‘link’ with the Australian scheme. International linking is an important element in reducing the overall costs of the scheme and the ability to establish future links with international schemes is an important consideration in the design of the Australian scheme. [33] Finally, business perceptions of compliance by other businesses with the scheme could have implications for their own compliance. That is, if one emitter believes that other emitters are non-compliant with the scheme, this may influence their compliance decisions. In closing, it is important to note that, in considering impacts on the credibility of the scheme, perceptions of non-compliance can be more important than the actual level of non-compliance. [34]

Misreporting of emissions would also have a number of implications at a firm or industry level. The emitter that underreported emissions would be placed at a competitive advantage vis a vis other market participants (as they would need to surrender fewer permits). This advantageous position would be a result of non-compliance with the law rather than legitimate business practices and could entail significant costs for competing entities.

For these reasons, assurance arrangements to certify the accuracy of emissions reporting are required. Three options exist:

•        ex-post audits undertaken the Government

•        ex-ante audits undertaken by third party auditors

•        a hybrid option involving third party audits for very large emitters (those emitting over 125 kt CO 2 -e/year) and Government assurance for liable emitters below this threshold.

The first option would be similar to the general taxation arrangements. Business would submit their emissions reports and the regulator would then undertake audits in a random (or targeted) manner.  The second option would be similar to the arrangements for the preparation of financial statements under the Corporations Act 2001 . Reporting entities would be required to appoint an independent third party to audit emissions reports before they are submitted to Government.

Under the second and third options it is expected that (at least initially) most audits would be undertaken by large accounting and consulting firms. The extent to which specific training and qualifications will be required before a person can undertake these audits is currently the subject of a detailed consultation paper released by the Department of Climate Change on external auditing of emissions information. The Government will consider industry views about relevant skills and expertise, and compliance costs in finalising policy positions on this level of detail. Over time, smaller specialist firms may provide these services at lower cost than the large accounting and consulting firms.

There are two main costs associated with ensuring the accuracy of emissions reports — compliance costs incurred by business in seeking third party audits and administration costs associated with Government activities to ensure the accuracy of reports.

For those businesses that are required to obtain third party audits, the cost is estimated to be $150 000 per year.  It is also likely that companies would incur some costs associated with liaising with the auditors. On average these are estimated to be around $11 500 per business per year. Obviously the overall compliance costs would be largest under option 2 — all business would be required to obtain audits. Assuming there are around 1000 liable entities, this would entail total aggregate compliance cost of around $164 million per year. [35] The third option would only require around 200 businesses to seek third party audits. The total compliance costs of this option are estimated to be around $33 million per year. The compliance costs associated with the first option are minimal.

In terms of administrative costs, it is estimated that the cost to Government of the third (hybrid) option would be around $5 to $9 million per year. This represents the costs to Government of undertaking audits of a selection of emissions reports submitted by liable entities both to double check the reports of vary large emitters and assure the accuracy of reports by smaller liable entities. The administrative costs of the first two options have not been separately estimated, but these costs would be significantly higher under the first option (reflecting the fact that no auditing had been undertaken by companies and the government would need to undertake a significant number of audits to obtain an acceptable level of confidence that the emissions reports were accurate) and significantly lower for the second option (reflecting the fact that all companies had already been independently audited).

Overall, it is expected that the first option (no third party audits) would be the least costly option while the second option (third party audits for all liable entities) would be the most expensive.

The benefits of assuring emissions reports are essentially the flipside of the costs of inaccurate reporting detailed above. That is, ensuring that emissions reports by liable entities are accurate will improve the accuracy of national emissions estimates, provide additional confidence in the scheme and minimise any business distortions created by the misreporting of emissions. While these benefits are not quantifiable, it is expected that the options involving third party auditing would offer greater benefits. Third party auditing would assure the accuracy of each report (where as Government auditing would only consider a subset of reports) ensuring the accuracy of overall emissions estimates. Third party auditing is also more easily observed by relevant stakeholders (than ex-post Government assurance) ensuring the confidence in the accuracy of reports is maintained.

The benefits associated with the third (hybrid) option are lower than under the full third party assurance option as only a subset of emissions reports are assured. However, the benefits are not likely to be significantly lower. The majority of emissions are accounted for by very large emitters (over the 125 kt CO 2 -e/year threshold). As a result, assuring the accuracy of these emissions will ensure that overall emissions data are largely correct. Moreover, the very large emitters are likely to be the most ‘visible’ and ensuring the accuracy of these reports should provide confidence in the accuracy of emissions data for the majority of stakeholders. Any concerns with the accuracy of reports by smaller emitters can be alleviated (to a degree) by additional assurance activities undertaken by the regulator.

Submissions generally supported the need for a strong framework to assure the quality of emission reporting submitted under the scheme (Chevron). However, a number of stakeholders did not agree that assurance of emissions reports should be conducted by independent third parties prior to submission to the Government under the scheme. For example, both the Energy Supply Association of Australia and the Australian Petroleum Production & Exploration Association argued that a self assurance model would minimise compliance costs for liable entities.

On balance, it is considered that the hybrid option represents the best balance of risks to scheme credibility and compliance costs for reporting entities and is the preferred option. While it is more costly than the first option (Government audits), it is considered that mandatory third party auditing is essential to ensure confidence in the scheme. The second option would provide some additional benefits, however these are likely to be limited and this option would be substantially more costly.

In implementing this position the regulator will monitor the reports of all emitters and will have the power to review and amend assessments of emissions for up to four years after the date of assessment (if reports are found to be erroneous). This time period is broadly consistent with amendment periods under current business tax provisions for entities with complex affairs. In addition, the regulator will have the power to impose administrative penalties, and seek civil and criminal penalties, in the event that emitters are non compliant with the law.

If there are concerns about the accuracy of reports for reporting entities with emissions less than 125 kt CO 2 -e/year, the regulator would consider the need to extend auditing requirements (this decision would be taken by Government). 



5)      Linking the scheme to international markets

Climate change, by its nature is a global problem where the location of abatement does not affect its contribution to addressing the problem.

An international carbon market already exists under the Kyoto Protocol to the United National Framework Convention on Climate Change [36] , and some other countries have developed, or are developing, domestic emissions trading schemes (see below).

Opportunities for linking are likely to increase substantially over time, as more countries take on binding emissions constraints and seek to use domestic emissions trading schemes to achieve their targets at least cost.

The existence of other international schemes provides opportunities for Australia to ‘link’ with these schemes. Linking involves importing units from other schemes and /or exporting units from Australia.  The key question is how and under what circumstances Australia should link its scheme with international markets and the schemes of other countries. 

Current international arrangements

The Kyoto Protocol establishes a framework for emissions trading. The Protocol sets out limits on emissions from each developed country and countries with economies in transition for the 2008-12 period (the ‘first commitment period’).

The Kyoto Protocol also provides a framework for parties to acquire Kyoto units from other countries and count them towards their emissions targets via different mechanisms (emissions trading, the ‘clean development mechanism’ and ‘joint implementation’ projects). Each mechanism produces a different type of compliance unit (worth one tonne of CO 2 -e) that may be traded amongst countries (these are discussed in more detail below).

All of these units are eligible compliance units under the Kyoto Protocol; that is, each can be used to offset one tonne of CO 2 -e from any party’s emissions. As such, each type of compliance unit could be accepted for compliance in the scheme, linking the Australian emissions trading scheme to the international market.

One major advantage of linking via the flexibility mechanisms is that the international architecture ensures the credibility of the units traded. By linking with the flexibility mechanisms many of the benefits of directly linking to other domestic and regional schemes can be achieved as these scheme’s are also linked to the flexibility mechanisms.

It should be noted that the first commitment period of the Kyoto framework will end in 2012. At this stage it is not certain what arrangements will be introduced for the post-2012 period as these are the subject of current international negotiations. As such, it is important that some flexibility remains over future linking arrangements so that they can reflect developments in the international architecture.

Domestic emissions trading schemes are at various stages of development. Most countries implementing or developing emissions trading are parties to the Kyoto Protocol. The European Union has had a successful emissions trading scheme operating since 2005. Norway also has an emission trading scheme that is linked to the European scheme. The New Zealand Parliament passed legislation enacting their emissions trading scheme this year. Following the change of government in New Zealand, its scheme is under review, however the new Government remains committed to a modified emissions trading scheme. Proposals are also at various stages of development in Canada, the Untied States, Japan, South Korea and Switzerland.

Where Australia links directly to the scheme of another country with a Kyoto target, any trades between the scheme could be counted towards meeting Australia’s Kyoto target. As such, the detailed design of the specific domestic scheme is less relevant as the trade is backed by the credibility of the Protocol.

Criteria

Determinations on all design elements of the scheme, including linking, have been made with reference to the standard scheme criteria. In relation to linking arrangements there are several criteria of particular importance:

•        Environmental integrity: the integrity of the units of trade (that each unit actually represents an additional tonne of abatement) is important. Also, since stabilising global emissions at a safe level will require widespread, sustained and significant international action, linking options can also be assessed by their impact on Australia’s ability to shape global solutions to the challenges posed by climate change.

•        Economic efficiency: linking will have implications for domestic scheme compliance costs, the credibility and predictability of the scheme, and promotion of least cost reductions in emissions.

•        Minimising implementation risk: a complex scheme design poses greater risks to the scheme’s smooth commencement. Linking arrangements will have implications for the simplicity of the scheme. It is desirable that the scheme avoids design parameters that could lead to erratic and unpredictable pricing behaviour. The transition to the scheme will be easier if prices are able to rise gradually over time. In particular, erratic and unpredictable prices could have implications for the ongoing credibility of the scheme. Also, strong opposition to specific elements of the linking design may lead to the delay in, or difficulty with, implementation of the scheme more generally.

•        Policy flexibility: it is desirable that linking arrangements allow the scheme design to respond to changes in international obligations and arrangements.

•        Promoting international objectives: linking arrangements should be consistent with Australia’s international objectives, including any internationally agreed emissions reduction obligations.

The merits of linking

The first benefit of linking relates to the cost-effectiveness of emissions reductions and the economic efficiency criterion. An effective global market with a credible global constraint on emissions and unlimited linking between countries would reduce global and Australian abatement costs by ensuring that the cheapest abatement opportunities are pursued first, regardless of where they occur.

For example, if the cost of domestic abatement were greater than abatement in other countries, it would be cheaper for Australian businesses to purchase permits from international markets than to abate themselves. This option would not be open to Australian businesses under a closed scheme (they would have to purchase permits from the domestic market at higher cost).

In a world with an effective global market, for Australia to achieve its emissions reduction targets solely through domestic abatement (that is in a closed scheme with no linking) would be more costly and would deliver no additional environmental gain.

The second distinct advantage of linking is that it can encourage the development of global carbon markets. As Garnaut and many stakeholders recognise, the promotion of emissions trading as a mechanism is advantageous for global mitigation and therefore assists Australia to promote its international objectives.

While there are significant benefits from linking there may also be some drawbacks.

Linking the Australian scheme to international markets means that the price of Australian permits will be set by international supply and demand conditions instead of domestic supply and demand conditions. International carbon prices could fluctuate largely as a result of political decisions by other Governments and Australia would have no control over those decisions. In particular, the current significant uncertainty about future international arrangements could lead to substantial price uncertainty and volatility. This uncertainty and volatility could impose significant costs on businesses who have to make long term investment decisions, the profitability of which would depend on the international carbon price. The uncertainty about future international arrangements is unlikely to be fully resolved before the commencement of the scheme and may pose difficulties in managing a smooth transition in the early years of the scheme.

It may be desirable to have a higher degree of domestic abatement to ensure the ongoing credibility and acceptability of the scheme. There is a view amongst some stakeholders, particularly conservation groups, that the scheme should encourage domestic action and not rely heavily on imported permits.

Overall, international linking would be a positive addition to the scheme, however, careful consideration needs to be given to different linking opportunities.

Options

In broad terms, links with other schemes can be described as either:

•        direct, where units from scheme A can be used for compliance purposes in scheme B; or

•        indirect, where schemes A and B have no direct links but both accept units from scheme C, creating an indirect pricing link between them.

In addition, links can be either:

•        unilateral (one way), where units from system A can be used in system B, but not vice versa; or

•        bilateral (two way), where Governments responsible for schemes A and B agree to accept units from each other’s schemes.

Within these broad types of linking options, the Government would need to make choices about:

•        the types of international units that might be accepted for compliance in Australia

•        whether any restrictions should apply to how many international units could be accepted for compliance in Australia

•        whether Australian permits could be transferred outside Australia and, if so, how many.

The types of international units that might be accepted for compliance in Australia

There are two categories of international units that could be considered for compliance in the scheme:

•        international Kyoto units or

•        international non-Kyoto units.

To be consistent with the environmental integrity criterion, it would be important that the scheme recognise only units from schemes that are robust and credible.

Another key consideration, relating to the promoting international objectives criterion, is whether the use of international units should be restricted to those that can be counted towards Australia’s national target under the Kyoto Protocol, or whether other units should be allowed.

International units that cannot be counted towards Australia’s national target are referred to as non-Kyoto units. Possible sources of non-Kyoto units include those generated in the US, voluntary market credits, and those from abatement not currently recognised under the Clean Development Mechanism, such as avoided deforestation. While allowing for the use of robust non-Kyoto units for compliance would widen the field of available abatement options and potentially lower compliance costs, it would increase the cost to Australia of meeting its international obligations, since those units would not count towards Australia’s Kyoto target. As such the preferred approach is that non-Kyoto units would not be recognised for compliance purposes in the scheme, however, this position would be reviewed for the post-2012-13 period in the light of future development in the international architecture.

International Kyoto units are established by the Kyoto Protocol framework and can be used towards meeting Australia’s Kyoto target. As noted above, there are three flexibility mechanisms built into the Kyoto protocol: emissions trading, the Clean Development Mechanism and joint implementation projects. These generate four different Kyoto units, each of which could be accepted in the context of the Australian scheme as meeting emissions liabilities. The merits of accepting each of these units is discussed below.

Assigned amount units

Assigned amount units (AAUs) are the primary compliance units under the Kyoto Protocol, and are issued to countries in line with their agreed national emissions targets. For example, Australia agreed to cap emissions at 108 percent of 1990 levels over the Kyoto compliance period and has therefore been issued with AAUs to cover these emissions.

Consistent with the economic efficiency criterion, acceptance of AAUs is likely to provide liable entities with a low cost compliance option, lowering the overall cost of meeting the Government’s abatement targets.

However, there are some disadvantages to the acceptance of AAUs for compliance in the scheme:

•        Some stakeholders have raised concerns about the environmental credibility of some AAUs, specifically those that relate to so-called ‘hot air’ or surplus AAUs allocated to those countries whose economies have contracted since 1990. Those concerns centre on the argument that use of these AAUs in Australia would not necessarily mean that emissions would be reduced elsewhere (that is, they would not represent genuine abatement). Acceptance of AAUs in the scheme is likely of raise significant opposition from some stakeholders.

•        Given the current uncertainty about the future international framework, it is not clear how the supply of AAUs will develop. The volume of surplus AAUs is potentially large compared to the expected compliance shortfall for Kyoto parties in the first commitment period. The World Bank estimates that the compliance shortfall for Kyoto parties in the first commitment period could be 3.3 billion tonnes CO 2 -e, after taking account of domestic sinks. AAUs have the potential to deliver some 7.1 billion tonnes CO 2 -e. 21 This potential oversupply would have implications for the global price (although this will depend on the number of AAUs banked for use in future periods). If Australia recognised AAUs for compliance in the scheme this price uncertainty would have implications for scheme stability.

Given the potential risks to the credibility and stability of the scheme the preferred approach is not to accept AAUs for compliance in the scheme. This position would be reviewed in the light of international developments.

Emissions reduction units

Emissions reduction units (ERUs) are generated via joint implementation projects where one country implements a project to reduce emissions in another country (both countries must have a target under the Kyoto Protocol).

ERUs would offer a low-cost compliance option for liable entities, promoting a cost-effective way for the scheme to help meet Australia’s emissions targets. Also trade in ERUs represent trade within the aggregate emissions constraint imposed by the Kyoto Protocol and could be considered more effective than trade in international offset credits from uncapped sources.

Overall, there are no significant risks associated with the recognition of ERUs in the scheme so the preferred approach would be to recognise these units.

Removal units

Removal units (RMUs) are units issued by another Kyoto party on the basis of land use, land-use change and forestry. Few countries are likely to be in a position to generate RMUs, so the potential for trade in RMUs is likely to be limited. No concerns have been raised about the use of RMUs, and preferred approach is that RMUs be recognised as compliance units in Australia’s scheme.

Certified emission reductions

Certified emission reductions (CERs) accrue from joint projects between Kyoto parties with an obligation (developed countries) and developing countries under the Clean Development Mechanism. Essentially, the developed country can implement a project in the developing country and obtain CERs which they can use towards their Kyoto target.

The Clean Development Mechanism is designed to provide emissions reductions that can be used by Kyoto parties with an obligation to meet their commitments under the Protocol as well as support sustainable development in the host country. It is an offset mechanism that generates CERs based on differences between an estimated baseline (expected ‘business as usual’ emissions) and actual emissions.

The Clean Development Mechanism has induced significant abatement activities in developing countries and provides an important source of low cost abatement opportunities. Trade in CERs is an important component of the current international market, adding to overall liquidity.

In addition, the Clean Development Mechanism provides an important transition mechanism that engages developing countries in mitigation projects until they are able to take on binding commitments.

However, some stakeholders have raised concerns about the environmental credibility of the clean development mechanism, as it entails no limit on emissions in developing countries. Further, although the mechanism uses rigorous verification procedures, any assessment of whether abatement is truly ‘additional’ entails a significant degree of judgment.

It should also be noted that different rules apply to afforestation or reforestation activities in developing countries. These projects are assessed to have a limited life — less than two commitment periods for some projects and between 20 and 60 years for longer term projects — before they need to be replaced. If these CERs were recognised in Australia’s scheme, the Government would need to replace them with other units when they expired. Acceptance in the scheme would introduce a contingent liability on Australia under the Kyoto framework and would have high administrative costs associated with measures to address the contingent liability.

The preferred approach is that CERs be recognised in the emission trading scheme. This would not extend to CERs for afforestation and reforestation projects which have associated contingent obligations and high administrative costs.

Restrictions on how many international units can be accepted for compliance

Having decided what types of international units will be accepted another key consideration is whether the scheme should have any restrictions on the number of international units that can be used for compliance.

The chief advantage of not limiting the number of Kyoto units that can be used for compliance is that domestic compliance costs would be minimised - liable entities would purchase such units only if these units were less expensive than domestic compliance options. This is consistent with the economic efficiency criterion. Allowing unlimited access to international units would mean that the international price would act as a useful ‘safety valve’ on domestic compliance costs. Imposing limits on access to international units means that the domestic price for permits could deviate from the international carbon price. Unlimited access to international units would also inject greater liquidity into the Australian market.

However, there are also potential disadvantages associated with access to an unlimited number of international units including:

•        the requirement under the Kyoto Protocol framework for the use of flexibility mechanisms to be supplemental to domestic action (referred to as the supplementarity principle)

•        the potential implementation risks associated with exposing the domestic scheme to the current uncertainty about future international arrangements that could lead to significant uncertainty and volatility in the international price

•        the potential desirability of having a higher degree of domestic abatement to ensure the ongoing credibility and acceptability of the scheme.

There is no requirement under the Kyoto Protocol to quantify supplementarity. Also Australia is projected to meet its Kyoto target on the basis of existing domestic policy mitigation measures and other ongoing measures such as the Mandatory Renewable Energy Target and energy efficiency measures which will ensure that an adequate level of abatement is achieved domestically regardless of the design of the scheme.

Domestic abatement will occur under the scheme even with unlimited access to international units. The scheme will reduce emissions in Australia by introducing a price on carbon. Where the price is above zero, emissions will be reduced compared with what they would otherwise have been. With unlimited access to international units the domestic price for carbon will converge with the international price. It is expected that the international price will remain above zero. This means that all domestic abatement that is cost effective at that price will occur.

Economic modelling by the Treasury suggests that even with completely open access to international units after 2020, the scheme will drive significant reductions in Australia’s domestic emissions from what they would otherwise have been. For example, in the Carbon Pollution Reduction Scheme -5 scenario, Australia's domestic emissions are projected to be twenty-five per cent lower than the reference scenario in 2020, and sixty per cent below the reference scenario in 2050.

In regards to concerns associated with exposing the domestic market to the potential uncertainty and volatility in the international market, analysis undertaken by consultants Booz & Co of expected supply and demand conditions in the international market indicates that, while significant uncertainty remains there is a reasonably well functioning and forward looking international market with the capacity to deal with this uncertainty. Following consultation with stakeholders, there does not seem to be widespread concern about the implications of potential price volatility in international markets. 

Recognising the benefits of unlimited access to international units in ensuring liable entities have access to low cost abatement opportunities and in providing a ‘safety valve’ for domestic prices, the preferred approach is to not limit the number of international units that can be used for compliance in the scheme.

Transferring Australian permits outside of Australia

Transferring Australian permits to other countries would reduce the number of permits in Australia’s scheme, increasing the Australian permit price and resulting in relatively more abatement occurring in Australia than would otherwise be the case. The capacity to sell and transfer domestic abatement to international markets would also create new markets for providers of domestic abatement. It would increase the inflow of foreign capital, providing a stimulus for domestic abatement activities and investment in low-emissions technologies, and contribute to reducing the costs of global mitigation and to increasing global liquidity. The ability to sell Australian permits into foreign markets is, therefore, generally desirable.

However, some short-term factors need to be taken into account, particularly in minimising implementation risk. Adding international demand to the domestic scheme has the potential to increase upward pressure on the domestic price of Australian permits. This poses risks to the stability of domestic prices and, as a consequence, compliance costs, during the period in which the scheme is being bedded down. Allowing for the sale and transfer of Australian permits could also add complexity to the scheme. Neither of these impacts are desirable while market participants are adjusting to the scheme’s introduction.

Additionally, the Government would need to comply with the commitment period reserve of the Kyoto Protocol. That requirement would mean that the Government could not allow for the unlimited transfer of Australia’s Kyoto units to international markets, and that the commitment period reserve would need to be managed.

The preferred approach is to not allow the transfer of Australian permits outside of Australia in the initial years of the scheme.

Consultation

The majority of stakeholders consulted are supportive of linking, noting that it is a cost-effective way of meeting Australia’s emissions reduction targets and that linking can encourage the development of global carbon markets. Some stakeholders argue against linking because they would prefer that Australia meet its national emissions targets from domestic action alone.

Most stakeholders are supportive of linking to the Kyoto Protocol’s flexibility mechanisms. However, some stakeholders question the credibility of some Kyoto units, particularly CERs.

Many stakeholders are not supportive of a quantitative restriction and argue that a least cost approach would be to have unlimited use of credible international units and that this would provide a valuable ‘safety valve’ on the permit price in the Australia scheme. Those that do not support unlimited access to international units have a preference for domestic abatement.

Some stakeholders would support a quantitative restriction to comply with international obligations or to ensure scheme credibility but consider that in general the price should dictate the extent of use, and as such, restrictions should be set very high.

In response to the strong stakeholder preference for unlimited access to international units, the Government has changed its preferred approach from that which was indicated in the Green Paper and is now proposing not to have any quantitative restrictions.

In regards to the types of international units that would be recognised for compliance in the scheme, most stakeholders are supportive of the preferred approach. A small number of stakeholders - primarily environmental non-government organisations including Greenpeace, Friends of the Earth and the Australian Conservation Foundation - urge the government to narrow the scope of CERs permissible in the scheme, requesting that only ‘gold standard’ credits from the Clean Development Mechanism be accepted.

The majority of submissions accepted the restriction on non Kyoto units for compliance purposes but urge the Government to push for recognition of reducing emissions from deforestation and degradation (REDD) credits in any international agreement in the post 2012 period.

The decision not to allow the export of Australian units was recognised as sensible but potentially ineffectual due to the unlimited banking of permits that the scheme proposes to allow.  In recognition of the potential upward price potential which may result from the market pricing in expectations of the future value of export, the Government has decided to delay a decision to allow for export to a point some years after the scheme has commenced operation.

Several of the submissions called for the provision of certainty as soon as possible and as far in about the future as possible on the qualitative restrictions that will be placed on the import of Kyoto units. Generally it was requested that changes to linking rules also be subject to the ‘five-year rolling rule’ (that is, five years notice should be given by Government of changes in linking arrangements). In accordance with these views, the Government will provide five years’ notice on elements of linking policy that are key determinants of price.

There was overwhelming support for a continued effort to develop more direct bilateral or regional links in the future, particularly with New Zealand, Papua New Guinea and Indonesia. New Zealand has legislation in place for its emissions trading scheme although as noted above, the new government is reviewing the scheme. Neither Papua New Guinea nor Indonesia have proposals to develop emissions trading schemes presently. As Garnaut notes however (Garnaut Climate Change Review, p. 340), both ‘have large opportunities to reduce land-use change and forestry emissions and to quickly replace coal (Indonesia) and petroleum with low-emissions fuels’.

Future arrangements

Choices about the nature and extent of linking are likely to change over time.  Obviously, a key event influencing further decisions on international linking is the development of future international agreements. Linking arrangements will be subject to review in the light of ongoing international negotiations and market developments, with a clear preference for relaxing restriction on linking with credible schemes and mechanisms as the Australian scheme matures. Only those linking opportunities that are consistent with the scheme’s objective would be considered. This would include consistency with Australia’s international obligations.

There are potentially significant benefits associated with deeper and more expansive linking in the longer term. The Government could consider establishing a bilateral link with a scheme of another country by recognising the unit of the other scheme for compliance purposes and vice versa. Australia may wish to establish a bilateral link with the scheme of another country to increase the pool of abatement opportunities for liable entities, to enhance liquidity and to build international cooperation around emissions trading.  For example, a link between the Australian scheme and the New Zealand scheme would reduce compliance costs for trans-Tasman businesses and also offer potential opportunities for sharing governance arrangements and technical resources (for example, auditors and accreditation resources). 

In order to provide guidance to market participants about potential future links it is desirable to specify the characteristic of acceptable links.

Future bilateral links should only be with schemes that are of a suitable standard, including having:

•        an internationally acceptable (or where applicable a mutually acceptable) level of mitigation commitment

•        adequate and comparable monitoring, reporting, verification, compliance and enforcement mechanisms

•        compatibility in design and market rules.

These characteristics would help to ensure future linking arrangements are consistent with the scheme’s overall objective.

It is also desirable for market participants to have a degree of certainty about future linking arrangements, consistent with retaining enough flexibility to respond to changing international arrangements. It is proposed that, the Government will provide at least five years’ notification of a change to linking arrangements including the establishment of a new bilateral link, except where:

•        an independent review, including stakeholder consultation, finds that establishing a bilateral link with another country will not have a significant impact on the permit price in the scheme; and

•        the responsible minister decides to waive or shorten the notice period.

In addition, if Australia were to link with another country’s scheme, it would also indirectly link to all other schemes to which that scheme is already linked. Therefore it would be desirable that in making an assessment on whether to link the Government took into account any existing links of the other scheme.



6)      Auctioning of Carbon Pollution Permits

Once created, carbon pollution permits within the scheme cap need to be allocated or released to the market either by allocating them to liable entities or by auctioning them.  As discussed below, auctioning is an efficient method of allocating permits. However, auctioning such a large number of permits raises important issues of auction design.

The objectives of the auction

The design of the auction will be influenced by the objectives it is seeking to achieve. The key objectives are as follows:

•        Promote allocative efficiency  — Permits are channelled to their highest value in the economy with a minimum of risk and transaction costs.

•        Promote efficient price discovery  — Making the auction results public will provide an important price signal early in the scheme.  Providing a price signal has a significant role in stimulating behavioural change; for instance in helping entities manage their emissions obligations and make investment decisions.  This discovery process is reinforced when the results of early auctions and the prices obtained are communicated at the start of the scheme.

•        Raise auction revenue  — The auction should also raise revenue that can be used for other policy objectives, such as providing assistance to households and businesses. However, the auction has not been designed with the primary aim of maximising revenue.

There is usually no conflict between the objectives of promoting allocative efficiency and price discovery, and raising auction revenue. If conflict arises, the Government will give priority to the first two objectives.

To promote allocative efficiency and efficient price discovery a well-designed auction will include:

•        a large competitive field of bidders;

•        a simple system that encourages participation;

•        a stable set of auction rules that are not subject to arbitrary or unpredictable changes;

•        transparent processes that rapidly reveal price information; and

•        minimal fees, charges and other costs of participation (although some rules to ensure that bids are credible may be desirable).

In arriving at final policy positions, the Government has sought to ensure that the development of a deep and liquid secondary market is not compromised.

Advantages of auctioning as an allocation method

In releasing permits to the market, the Government has two options: the auctioning of permits and allocating them directly to emitters.

Auctioning permits has a number of advantages over allocating them directly to liable entities.

In theory, there should be no difference in efficiency between auctioning permits and allocating them administratively [37] , because permits could be traded to their highest value use under either system, even if the initial allocation is inefficient.

In practice, because administrative allocations will be made for reasons other than pure efficiency, the initial allocation of permits will not necessarily be made to the users that value them highest. Firms will be able to trade permits on the secondary market, but trading costs and information issues mean that this will not be costless. As a result, additional transaction costs will be incurred under a direct allocation method to ensure that permits reach their highest value uses.

Auctioning permits also ensures that the entities who are responsible for high levels of emissions are the ones that pay for the environmental costs (the ‘polluter pays’ principle). It also raises additional revenue for the Government which can be directed to different areas (in this case assistance to business and consumers).

The key disadvantage of auctioning permits is that it may be slightly more expensive for Government depending on the nature of the administrative allocation method. However, auctions will be held on an internet platform to reduce the cost to Government and participants, and in the context of the scheme auction establishment, running costs are expected to be low. Even with direct allocation the Government would incur costs associated with designing and implementing the allocation approach.

Most stakeholders were in favour of auctioning as the preferred approach to releasing permits. One issue that arose was the free allocation of permits as part of assistance packages for strongly affected industries and emissions intensive trade exposed industries. Some stakeholders were in favour of auctioning 100 per cent of permits. These included the Australian Financial Markets Association and the Garnaut Final Report. [38]

Other stakeholders, such as Visy Australia raised concerns that full auctioning might not result in an equitable allocation of permits as some industries will be disproportionately affected by the introduction of the CPRS.     

Some stakeholders were opposed to the distribution of permits by administrative allocation. They included the Construction, Forestry, Mining and Energy Union who argued that free allocation encourages gaming behaviour, leads to windfall profits and weakens the intended outcomes of the scheme.

The economic efficiency benefits of auctioning (the ability to channel permits to their highest value uses with lower compliance costs) make it highly desirable to move progressively towards 100 per cent auctioning of permits over the longer term. However, the use of permits to provide assistance to industry is an important element of the proposed assistance packages. As such, some initial free allocations of permits to emissions intensive industries will be made.

The preferred position is that allocations will, over the longer term, progressively move towards 100 per cent auctioning as the scheme matures, subject to the provision of transitional assistance for emissions-intensive trade-exposed industries and strongly affected industries.

The key design features of the auctions under the Carbon Pollution Reduction Scheme

The Green Paper’s detailed proposals on auction design drew heavily on a report on auction design by Evans and Peck, which was commissioned by the National Emissions Trading Taskforce. The Government’s final positions on auction design have taken into account that report, stakeholder submissions, and further expert advice from Tradeslot Pty Ltd who was commissioned by the Department of Climate Change to provide expert advice on the design of auctions.

Auction Frequency

In theory, auctions could be held a number of times each year, for example weekly, quarterly or annually.

Several stakeholders requested that auctions be held more frequently than quarterly as proposed in the Green Paper. Stanwell Corporation Limited, ExxonMobil and Frontier Economics wanted more frequent auctions with monthly being the most requested.

More frequent auctions will mean smaller auctions. The frequency of auctions and its impact on the size of the auction will have implications for:

Reliability of price information —  More frequent auctions might reduce the reliability of the price information used to inform investment decisions early in the scheme. The price signal should be as reliable and efficient as possible.

The price should reflect market expectations about the demand and supply of permits, and the bidding field should be competitive and representative of the broader market. Smaller and more frequent auctions could lead to fewer participants and compromise the accuracy of price information from the auction. To reduce this risk, the Government will auction some minimum number of permits at each auction.  Peter Cramton, an auction consultant working on behalf of Tradeslot, recommended that the Government target around 5 per cent of permits to be sold at any one auction as a minimum auction size required for competitive bidding. 

Timeliness of the price signal —  More frequent auctions could improve the timeliness of price signals, which would benefit businesses making investment decisions.

However, once the secondary market has matured, investors will have readily observable real time market prices as they do in other markets.

Absorptive capacity of the market —  The frequency and size of auctions may have implications for the absorptive capacity of the market (that is, its ability to accommodate large transactions). Smaller quantities of permits associated with more frequent auctions are likely to be more readily absorbed by the market.

Administrative costs —  More frequent auctions involve a higher administrative cost for the regulator, and potentially for bidders. However, the capacity to hold auctions on the internet means that costs are minimised and unlikely to be an important factor in determining auction frequency.

Development of the secondary market —  Some stakeholders, including Origin Energy and the Australian Securities Exchange, were concerned that greater auction frequency might delay the development of the financial services normally provided by the secondary market.

Cash flow and working capital management —  A number of stakeholders cited cash flow and working capital management as reasons for holding more frequent auctions. In particular there were concerns about working capital related to the timing difference between the purchase of permits and their surrender to meet scheme obligations. Many stakeholders were concerned that they would be required to borrow to purchase permits many months or even years in advance. Some were concerned that recent financial market uncertainty would mean that they would not be in a position to borrow the required funds or would be forced to pay interest rates that they could not afford.

Most of these stakeholders suggested monthly auctions, on the grounds that this would enable them to better manage their liabilities and reduce their working capital or debt financing costs. For example, TRUenergy argued for monthly auctions with weekly settlements to minimise the working capital and cash flow impact on affected energy market participants.

Other stakeholders, such as Caltex, supported weekly auctions because such auctions would reduce working capital requirements.

Frequent auctions may provide liable entities with an additional option for managing their obligations under the scheme, particularly given any working capital or debt financing constraints they may have. For example, they might want to align their expenditure on permits with their accruing liability over the compliance period. This is similar to the way businesses have developed strategies for managing their accruing tax liabilities.

In the presence of a functioning secondary market, the frequency of auctions should not affect liability management or the costs of working capital or debt financing. Permit prices, like prices of other financial assets, are expected to, on average, yield a return equal to a market interest rate sufficient to compensate investors for the risk of holding permits. Because permits do not pay dividends or interest, like shares or bonds, the return will come in the form of capital gains. That is, on average, permit values (prices) would be expected to rise at the market interest rate.

The permit interest rate and permit prices will also reflect economic conditions and the cost of capital. Lower economic growth or constraints on credit will reduce demand and cause the carbon price to be lower and permits to be more affordable for business. Because of this, the timing and frequency of permit purchases at auction will have a more limited effect on the current dollar cost of permits to businesses with similar costs of capital.

Assessment

The scheme design should include frequent permit auctions while maintaining the size and efficiency of each auction. More frequent, smaller auctions are more easily absorbed by the market, present a lower risk in the event of an operational failure of an auction, and perhaps provide business with more flexibility while the secondary market is maturing.

However, more frequent, smaller auctions have a number of disadvantages:

•        On average, they will have lower participation. The auction would then be more prone to manipulation and erratic pricing outcomes.

•        More frequent auctions could reduce the time businesses devote to information gathering and preparation, reducing the accuracy of some bids and the auction price signal.

•        They may also reduce the level of activity in the secondary market, especially if auctions are double-sided (that is, allow liable entities to both buy and sell permits).

While quarterly auctions could be sufficient, 12 auctions throughout the financial year will accommodate stakeholder demand for greater frequency while not unduly risking the efficiency of the auction process. This is the preferred approach. 

Auction settlement arrangements and deferred payment

A number of stakeholders, most notably those from the power generation sector, such as Loy Yang Power and TRUenergy expressed concerns over their capacity as individual businesses to manage the cash-flow costs associated with their significant permit purchase obligations. They argued that auction participants should be able to defer payment for permits until the relevant vintage year (for example, pay for 2013 permits in 2013 even if the permits are purchased at a 2010 auction).

Other scheme proposals and international experience provide limited guidance on optimal auction payment arrangements for a carbon market. The Task Group on Emissions Trading, the National Emissions Trading Taskforce and the New Zealand Emissions Trading Scheme did not make any specific recommendations about payment arrangements. In the European Union Emissions Trading Scheme, because of large-scale free allocations of permits, liable entities were not required to buy large parcels at auction, rendering payment terms irrelevant. Under the Regional Greenhouse Gas Initiative, financial settlement and transfer of permits to successful bidders occurred within 14 days of the first auction, although very loose caps under that scheme have meant very low prices ($3 per tonne of carbon dioxide equivalent).  The Garnaut Final Report recommended against lengthy deferred payment.

Deferred payment is likely to encourage participation in the auction of future vintages reducing the risk of low demand or unreliable prices for future vintages.

However, the provision of deferred payment arrangements has the potential to expose the Government to financial risk and would be administratively complex. Government provision of deferred payment terms may also disrupt the development of the secondary market needed for longer term risk management by business. This could occur for example, by Government service provision ‘crowding out’ the equivalent service in the private sector.  In the absence of Government provision, demand for these services is likely to be met by private sector financial intermediaries.   

Assessment

It will be important that, if a deferred payment arrangement was allowed, that all bids made during the auction must represent both final valuation and capacity to purchase ensuring the credibility of the auction. This would require the creation of a contract through the act of bidding, and the imposition of substantive penalties for buyers who default. Further mitigation strategies could include not transferring ownership until the permit is paid for, and implementing extensive credit checks.

There are a range of costs and benefits associated with the provision of deferred payment arrangements. These merit further consideration and a decision on whether to adopt deferred payment processes will be taken in due course.

Advance auctioning of future vintages

The scheme will have annual caps and surrender periods. Consistent with this approach, permits will also be differentiated by annual vintages; that is, each permit will pertain to a particular financial year scheme cap.

Box 6.1 :  International and other Australian scheme proposals

The expert auction report by Evans and Peck, commissioned by the National Emissions Trading Taskforce, recommended quarterly auctions of current year vintages and auctions of three future year vintages once a year (to be conducted simultaneously with one of the current year auctions).

The taskforce proposed auctions of current year and future year vintages. [39] However, it noted ‘scope for further work to refine timing and frequency as detailed scheme design progresses’ and that, in particular, ‘consideration should be given to the different incentives faced by bidders in relation to timing’. The Garnaut Final Report proposed one to two years (spot plus one future vintage), and the Regional Greenhouse Gas Initiative [40] four years (spot plus three future vintages).

The European Union Emissions Trading Scheme [41] and the proposed New Zealand Emissions Trading Scheme [42] do not include advance auctions of future vintages.

Most stakeholders, including the Australian Securities Exchange, supported the auction of future year vintages as future vintages may be an alternative to the spot market and any associated derivative markets for liable entities seeking to manage future emissions obligations.

Some stakeholders also argued for the issuing of vintages from distant future periods as a signal of scheme credibility and longevity. This is similar to the approach proposed in the McKibbin-Wilcoxen hybrid model for climate change policy, which uses long-term permits partly to give investors a stake in the longevity and credibility of the scheme. [43]

Advance auctions of future vintages are not required for carbon futures prices to emerge. For example, derivative markets have developed in the European Union Emissions Trading Scheme without advance auctions. While advance auctions can provide flexibility for liable entities and contribute to the credibility of the scheme, they can also increase the complexity of auctions and reduce the number of permits of particular vintages available at each auction. Depending on how far in advance vintages are auctioned, the Government’s flexibility to set caps could be reduced over time. The extent of these disadvantages will depend on how many future vintages are auctioned.

The key advantage of the advance auction of future vintages is that advance auctions would give entities trying to manage future emissions liabilities an alternative to buying up and hoarding the current year’s permits.

Assessment

It is important that the advantages of increasing flexibility and certainty for liable entities are balanced against the Government’s flexibility to set caps over time. Auctioning a greater number of future year vintages implies a smaller number available at each auction. Therefore, the preferred position is that auctions be held for the current year vintage plus each of the next three financial year vintages held once each year.

Auction participation

Universal participation would allow non-liable entities, including financial intermediaries, to participate in auctions.

Some stakeholders opposed this proposal, raising concerns that the participation of non-liable entities in auctions may result in speculation and the bidding up of prices. For example, Woodside Energy Limited argued that in order to ensure market liquidity and eliminate price risk, the Government should limit participation, at least initially, and restrict eligibility to register ownership of permits to firms which are emitters or which have permit surrender obligations under the scheme.

The Australian Food and Grocery Council also argued that allowing financial markets to participate in the auctioning process invites the possibility of manipulation over the carbon trading system, leaving genuine purchasers of permits at a disadvantage.

However, limiting auction participation would have a number of disadvantages:

•        An auction is more likely to deliver reliable price signals if the field of bidders is competitive. Restricting the number of bidders would reduce the competitiveness of the bidding field and increase the scope for market manipulation.

•        Smaller liable entities might prefer to use specialist financial intermediaries to help them manage their emissions obligations over the year, rather than directly participating in auctions. It would also give liable entities an unfair advantage in the secondary market over others who seek to provide such services.

•        In practical terms, it would be difficult to limit participation and enforce a restricted auction scheme, as excluded entities could simply contract with liable entities to buy permits on their behalf.

•        For liable entities to be able to manage their carbon cost price risks, they are likely to want to enter into hedging contracts. Not allowing other players, including financial market participants, to buy permits at auction is likely to slow the development of such hedging products, which would have the perverse outcome of making price risk less manageable.

However, to ensure that auctions are competitive and free of manipulation, it is envisaged that steps will be taken to ensure that bidders are credible. Those measures may include some form of financial guarantee or cash deposit to ensure that bidders will be able to pay for the permits they buy at auction, and to encourage only genuine participants. Depending on the number of permits a bidder acquires and the price at which they are acquired, either the deposit would be returned or the bidder’s payment would be reduced. 

A further way to limit market manipulation is limit the maximum number of permits that can be purchased at any one auction.  The Government plans to limit the maximum parcel of permits that can be purchased at any one auction to 25 per cent of the available amount. [44]

Overall, while some stakeholders opposed universal participation in auctions, there are significant benefits to opening up auctions to all parties and this is the preferred position.

Implementation

There are also a number of smaller implementation decisions that the Government meeds to make. It is also envisaged that implementing these decisions will result in an auction design with a number of attributes. These are outlined in box 6.1

The timing of the first auction

The first auction could be held, in theory, at any time before the start of the scheme or after the scheme has commenced.

Some permits could be auctioned in advance of the start of the scheme to provide early carbon price signals to businesses, enabling them to make more informed investment decisions. An early auction would also help to prompt the development of an active secondary market.

However, some practical considerations limit how early the first auction could occur.

The legislation establishing the scheme must have commenced before the first auction takes place. The current timeline suggests that this will not be until the second half of 2009. The national registry will also need to be completed before the first auction of permits, to enable permits to be held in accounts in the registry.

For the auction to generate reliable price signals, the first auction should occur after participants have been able to develop informed opinions about overall demand and supply conditions. In practice, this means that they would need to know the scheme cap (the supply of permits). Final announcements about the cap will not be made until early 2010.

Many liable entities will be required to monitor and report their emissions for the year ended 30 June 2009 under the National Greenhouse and Energy Reporting Act 2007 . Once it is made public, that information will be useful for liable entities and financial market analysts in assessing value in the market. The first greenhouse and energy reports must be lodged in October 2009. This implies that the first auction could be held in early 2010. This will give the carbon market three to six months of trading time before the first compliance period begins.

Stakeholders that commented generally supported the Government’s proposal to hold the first auction in early 2010, prior to the commencement of the scheme. However a few recommended an earlier start, for instance Origin Energy supported:

… an auction as early as practicable before the scheme commences. Ideally, the first auction should take place in the second half of 2009.

While earlier auctions would have benefits, the practical considerations discussed above mean that an earlier auction is unlikely to be feasible and the preferred position is that the first auction take place as early as is feasible in 2010, before the start of the scheme.

Auction Type

Over time, the secondary market will provide a range of services that better facilitate trading and risk management. However, such services might be limited in the short term, which may effect the efficient operation of the secondary market. Therefore, the Government has a role in providing some transitional auction services to reduce this implementation risk.

The following auction features will facilitate and encourage the participation of liable entities in the early years of the scheme, as familiarity with and confidence in the new environment develops.

Ascending clock

In an ascending clock auction, the auctioneer announces the current price. Bidders indicate the number of permits they are prepared to purchase at that price. If demand exceeds supply, the auctioneer raises the price in the next round and bidders resubmit their bids. This process continues until the number offered is equal to or greater than demand. Bidders then pay the price from the previous bid round.

Ascending clock auctions can also allow proxy bidding, in which bidders submit in advance their demand schedule for permits at various prices. These bidders would not need to participate further in the auction. This enables bidders to submit bids, as would be done under a sealed bid system, if this is more convenient (see below).

The ascending clock auction also provides information on the aggregate demand schedule at the end of the auction, which promotes efficient price discovery in the secondary market.

The Government initially favoured ascending clock auctions for a number of reasons, including their transparency of operation, and because they allow small players to ‘free ride’ on the information sets of larger players. With sealed bids, small players have no access to market information during bidding and could miss out on an allocation because of strategic bidding by larger operators.

However, to accommodate some stakeholders’ desire for simplicity, the Government will allow ‘proxy bidding’, as described above. Proxy bidding will replicate some of the advantages of a sealed bid auction, even where the auction type is simultaneous ascending clock.

Auction governance arrangements

Once established, the scheme regulator will be best placed to manage ongoing auction policy design and operational matters, with wide discretion prescribed in the legislative framework. This will result in an administratively more efficient outcome than requiring the responsible minister to approve small changes to auction design.

Auction rules will require different arrangements at the start of the scheme. This is particularly so because the scheme regulator might not be established in time to develop and consult on a detailed auction strategy before the first auction is held. Until the auction arrangements are established, operational flexibility within clearly specified objectives is desirable, because the auction design is likely to need to be fine tuned over time.

The Government has experience in auctioning other forms of property, such as the auction process for Treasury Bonds and has taken the governance arrangements operating in those markets into account in finalising its auction governance arrangements. 

Auction design decisions and operational rules will be made public.



Consistent with the preferred position in the Green Paper, the minister w ill make a disallowable legislative instrument determining the auction process and operational rules during calendar years 2010 and 2011. After that time, the regulator will have the power to make such an instrument. In both cases, the primary objectives will be to promote the efficient allocation and price discovery of permits. This arrangement will provide certainty for business.

Box 6.2:  Features of the auction

Uniform pricing

The ultimate price paid per permit will be identical for all successful bidders, regardless of their respective valuations. This is a natural outcome of the ascending clock system, and one that does not discriminate between bidders.

Aggregate demand revealed each round

At the end of every auction round, the auctioneer will provide information on the number of permits demanded by participants at the current price. To avoid collusion, individual bids will not be published.

Proxy bidding

Proxy bidding allows bidders to delegate actions to the auctioneer by submitting a set of bidding rules. Bidders can submit their permit demand schedules and then receive the amount specified at the final auction price. Proxy bidding in sealed bid format will not interfere with the operation, transparency or efficiency of the ascending clock auction; it simply automates bidder preferences. It does not remove the round-by-round disclosure of aggregate demand by the auctioneer.

Publication of auction results as soon as feasible

The market will be informed of the results of auctions in a timely fashion. As the auction system will be fully automated, results will be released within seven days of each auction.

Reserve price

The auction will have a reserve price set well below the expected market price. This is in line with arrangements in the United Kingdom under the European Union Emissions Trading Scheme. The reserve price will increase efficiency by limiting the abuse of market power or collusion by entities, and accelerating the auction process. It is an administrative mechanism aimed at improving the speed and efficiency of the auction and is not intended as a price floor in the market. Unsold permits will need to be sold at future auctions.

Internet auction platform

Auctions will be conducted using an internet platform. The internet platform will encourage more entrants and greater competition because it is low cost and readily accessible.

 



7)      Setting scheme caps

The scheme cap determines the number of domestic carbon pollution permits (permits) that will be issued by the Government. Allowable emissions across the sectors covered by the scheme will only be able to exceed the cap if this is matched by the surrender of eligible international units [45] , additional permits issued as a result of forestry activities or the destruction of synthetic greenhouse gases, additional permits issued under the price cap mechanism or, possibly, scheme offsets.

In a system with little or no international linkage, the interaction between the cap and the demand for permits is the primary determinant of the carbon price: the more stringent the scheme cap, the higher the price, all other things being equal. However, the Government has decided to allow unlimited imports of eligible international units from scheme commencement and to review the scope for exporting permits over time. 

If the international price is below the domestic price, this will create an incentive for liable entities to import cheaper eligible international units for use in acquitting their liabilities under the scheme. This is expected to reduce the demand for permits and decrease domestic prices causing these to converge on the international price which in turn will be determined by global abatement demand and supply conditions. In this instance, the domestic scheme cap will no longer be a significant determinant of domestic carbon prices. 

If the international price is above the domestic price there will be no incentive for liable entities to import eligible international units. In this instance, the domestic scheme cap will remain a key determinant of domestic prices until such time as the restriction on exports is lifted or the international price falls below the domestic price.     

As there is uncertainty over relative international prices and future international linking policy, guidance over scheme policy including scheme cap setting will be required to inform business investment.

The key driver of cost to the Australian economy will be the ambitiousness of the national targets that are agreed internationally.  The scheme cap will simply be set in accordance with these national targets.  The precise level of scheme caps is not discussed in this chapter.  

Guidance over scheme caps

There are four key questions that must be addressed in regard to the guidance over scheme caps:

•        Should announced scheme caps be adjusted in light of international developments?

•        How far into the future should scheme caps be set and announced and how often should this period be extended?

•        What additional guidance should be provided?

•        What is the approach for setting scheme caps?

Should announced scheme caps be adjusted in light of international developments?

Setting scheme caps for a certain period in advance is an exercise in risk management. There is considerable uncertainty about international developments after 2012, with little clear direction on the likely outcome of negotiations. If caps are set five years in advance, future shifts in the international situation may mean that the caps are inconsistent with Australia’s negotiated position. The critical question is whether the risk of inconsistency is borne by participants within the scheme or by tax payers.

If, following the advance announcement of scheme caps, the Government were to commit to a national emissions trajectory that is stricter than that implied by these scheme caps, it would have two broad options for meeting the national targets.

•        The Government could tighten the scheme cap to match the change in Australia’s international commitments. This could be done by buying back permits, or by reducing the number of permits that the Government sells at future auctions.  In both cases, a policy of altering the caps would transfer some of the risk of changes in Australia’s international obligations to participants in the scheme.

•        The Government could make up the shortfall on its own account rather than through the scheme. This could be achieved by the Government honouring international agreements through the purchase of eligible international units without changing the scheme cap. This is the approach recommended by the Garnaut Final Report.

Alterations to scheme caps after their announcement would be disruptive to the market because it changes the anticipated supply of permits, thereby weakening the value of announcing caps in advance. On the other hand, Government purchases of eligible international units quarantine the scheme from external shocks and provide investors and others in the broader economy with certainty about short-term caps. Further, the Government will take domestic commitments and objectives into account when negotiating international commitments and so is in a position to manage risks over such a time horizon. For this reason, the purchase of eligible international units by the Government is preferred.

Stakeholders including the Australian Financial Markets Association and the Australian Chamber of Commerce and Industry were broadly supportive of the Government making up the difference between scheme caps and internationally negotiated targets.  

However, some stakeholders advocated against the use of eligible international units to make up the shortfall. For example, the Hunter Community Environment Centre questions the environmental efficacy of eligible international units, and the Australian Network of Environmental Defender’s Offices argues this is against the ‘polluter pays’ principle.

While standing ready to purchase eligible international units presents a fiscal risk, this is likely to be small, since it is proposed that scheme caps extend for only five years (or else to the end of a known international commitment).

The preferred position is that the scheme cap not be adjusted in the event that it is incompatible with internationally negotiated national targets and, if necessary, the Government would make up any shortfall in internationally agreed targets by purchasing eligible international units.

How far into the future should scheme caps be set and announced and how often should this period be extended?

Duration of guidance period over scheme caps

Three broad options were considered for announcement of future scheme caps:

•        A long period of certainty, such as 10 years or more (recommended by the Task Group on Emissions Trading (TGET) [46] and the National Emissions Trading Taskforce (NETT) [47] ).

•        A medium period of certainty, such as five years (recommended by The Garnaut Climate Change Review: Final repor t). [48]

•        The minimum number of years required to align with the international commitment period. For example, the Government could provide just two years (2010-11 to 2011-12) to align with the current Kyoto Protocol commitment period. New Zealand [49] and the European Union [50] have aligned scheme caps with their international obligations in their emissions trading schemes.

Box 7.1: Duration of scheme caps in international and other Australian scheme proposals

The first commitment period under the Kyoto Protocol allowed for a five-year commitment period (2008-12). If the second commitment period were of the same five-year duration, it would run from 2013 to 2017. The United Nations’ negotiation for a post-2012 outcome is unlikely to address the length of the second commitment period before late 2009. In part the negotiated length of a second commitment period will depend on the emerging shape of the overall post-2012 package. The higher the level of ambition for developed and developing country commitments, the greater the desirability of locking in commitments over a longer time period.

The European Union Emissions Trading Scheme originally announced that scheme caps in Phase I would be set for three years, and for five years in Phase II. [51] It is proposed that in Phase III of the scheme, scheme caps will be set for eight years (2013 to 2020). [52]

A survey of European Union Emissions Trading Scheme stakeholders and participants, commissioned by the European Commission as part of its review of the scheme, indicated that uncertainty created by the short initial phase for scheme caps was the biggest obstacle to market liquidity. [53] A large majority of the companies and industry associations surveyed indicated that they would prefer phases of 10 years or more, with national allocation plans being announced two or three years in advance of units being allocated.

At the start of the New Zealand Emissions Trading Scheme, scheme caps will be known only for the years to the end of the Kyoto commitment period (2012). It is intended that domestic emissions trading scheme caps after 2012 will coincide with the period set for future international emissions commitments. [54]

In Australia, both the National Emissions Trading Taskforce (NETT) [55] and the Task Group on Emissions Trading (TGET) [56] recommended that firm caps be set for a period of 10 years, followed by a 10 year range of caps (called ‘gateways’).

The Garnaut Final Report has recommended that firm caps be set for five years, and that information on possible longer-term trajectories and a long-term target, which would be specified in advance, is provided. [57] Different trajectories would apply, depending on Australia’s international commitments. The Government would announce when the specified conditions for switching tracks had been met five years in advance of the intended switch. [58]

Several stakeholders argued for a longer period of known caps including the Australian Financial Markets Association, Origin Energy and Alcoa.  Ten years of certainty over scheme caps (or even longer as advocated by some stakeholders) would provide a greater information set with which to inform permit prices. This would help to guide investment proposals with longer payback periods.

However, Australia’s current international commitments have only been agreed to 2011-12. By extending deep into the future, a 10-year cap period risks significant misalignment between caps and further obligations that Australia might choose to negotiate and accept and may also unduly constrain Australia’s negotiating position.

Although providing certainty to liable parties, fixing scheme caps independently of Australia’s international position for that length of time exposes the Government to risk that it will be required to purchase eligible international units to make up any shortfalls that may result. 

A small number of stakeholders advocated much shorter periods of guidance including the Australian Network of Environmental Defender’s Office, Greenpeace, the Hunter Community Environment Centre and the Parramatta Climate Action Network.

Minimum certainty over scheme caps would align with the current Kyoto commitment period, ensuring consistency between the scheme and Australia’s international obligations. However, it would give only limited guidance to market participants and leave considerable uncertainty around the likely direction of Government policy.

Therefore, in the absence of clear direction in relation to international commitments, the Government must choose the minimum duration of scheme caps it will announce. This decision is finely balanced, however, five years of scheme caps at scheme commencement — consistent with the recommendations of the Garnaut Final Report — appears to strike a reasonable balance between the need for investment certainty and the need to maintain flexibility in relation to future international negotiations and commitments.

As a result, the preferred position is that scheme caps be announced five years in advance. This period may be extended in the event that the Government enters an international commitment with a longer duration.

Extensions of the guidance period

Scheme caps will need to be regularly extended in order to maintain an adequate level of guidance.  The National Emissions Trading Taskforce (NETT) and the Garnaut Final Report proposed that firm caps be extended by one year, every year, while the TGET recommended that caps be extended by five years, every five years.

A short interval for extending scheme caps (such as one year) has a number of advantages. A short interval would increase flexibility for the Government, which could make small extensions to the cap each year in response to developments in the economy, environmental science or international objectives and commitments. A short interval would help maintain a minimum period of certainty over caps at all times. It would also provide a more regular flow of information to the market about future emissions constraints, which could help promote a more continuous pricing response, rather than sharp, irregular adjustments.

The disadvantage of extending scheme caps by one year, every year, is that the administrative costs of gathering advice, consulting stakeholders and effecting the change through the appropriate legislative mechanism would be higher than if scheme caps were extended less regularly.  

Stakeholders including BP were broadly supportive of the proposed (year by year) approach to extending scheme caps.

On balance, it is considered that the need to ensure at least five years of certainty for business is important, even though this entails higher costs for Government. As a result the preferred approach is that scheme caps be extended by one year, each year, as required to maintain a minimum five-year certainty period.

What additional guidance should be provided??

To further inform the market the Government could also announce 'gateways' (ranges of scheme caps) beyond the five years of scheme caps.  Gateways are essentially a pre commitment by Government to ensure that the scheme cap at some future point(s) in time will be in a certain range. That is, for a set period in the future it offers a range of emissions outputs from which the Government would choose the scheme cap (see figure 7.1).

Figure 7.1 Scheme gateways

The Garnaut Final Report, TGET and NETT all proposed that some form of gateway be used. Similarly, caps for Phase III of the EU emissions trading system are currently expressed as a gateway. [59] In all of these proposals or arrangements, gateways take the form of a government commitment to a range of values for future caps.

The principal advantage of using gateways is that it allows the Government to provide more information to the market about future caps, but in a way that maintains a degree of flexibility. Providing information about constraints on future cap-setting would increase certainty over the path of the scheme cap would travel and would assist industry in planning new investments.

A second potential advantage is that a gateway could promote Australia’s international climate change objectives by signalling Australia’s readiness to commit to stricter domestic caps in the event that other countries make similar commitments.

The only major potential disadvantage associated with the use of gateways is that they might unduly constrain the Government’s flexibility in the event that it wished to set a cap that was outside the gateway range. However, that risk should be taken into account when determining the scheme gateways and needs to be balanced against the benefits of providing greater investor certainty and more accurate international signalling.

Few stakeholders commented on the use of gateways. Of these stakeholders most of them (such as the Investor Group on Climate Change and Transfield) expressed broad support for gateways as proposed, citing reasons of adequate gateway lengths that provided additional business certainty. However, a couple of stakeholders (such as the Australian Conservation Council) argued that gateways should not be used as they erode the flexibility of Government to choose significantly tighter scheme caps in the future. Some, such as Environment Business Australia, expressed preferences for shorter gateway lengths to reduce the risk to Government. To address these concerns gateways should be set taking into account progress in international negotiations.

Other stakeholders, such as the Business Council of Australia, preferred longer gateways lengths to give additional certainty to business. With more international linking, the domestic price is likely to converge on the international price. This will reduce the price relevance of domestic scheme caps and therefore the importance of gateway guidance over these. As stakeholders increasingly understand the importance of international prices, there will be less focus on gateways as an indicator of ‘certainty’.

Nevertheless, in the short to medium term, gateways can provide useful guidance with limited cost to government. As a result, the provision of gateways beyond the period of fixed scheme caps is the preferred approach.

What is the approach for setting scheme caps?

A primary aim of the scheme is to help Australia meet its emissions reduction targets in the most flexible and cost effective way. The scheme will reflect this national target through the stringency of the scheme caps.

Australia ’s emissions reduction targets are specified in terms of national emissions. Because the scheme will not cover all sources of emissions at commencement, the scheme cap and Australia’s total national emissions will be different. Emissions from covered sources will form only a subset of total national emissions. Therefore, there needs to be a clear relationship between the scheme cap and the indicative national emissions trajectory.

Since the gap between the scheme cap and the indicative national emissions trajectory relates to uncovered emissions, this raises the question of whether uncovered emissions sources should share in the national emissions reduction effort and, if so, how.

If sectors cannot be covered, consideration will be given to alternative mitigation measures. The purpose of such measures would be to ensure that uncovered sectors make an equivalent contribution to achieving Australia’s national emissions reductions objectives and have incentives to undertake abatement. Alternative mitigation measures could include regulatory requirements that entities meet certain emissions standards, or to adopt low-emissions technologies or management practices. To ensure an equivalent contribution, alternative mitigation measures would be designed to deliver abatement up to a cost that is roughly the same as the carbon price under the scheme. Decisions on these measures will be taken in due course.

To ensure that the scheme helps Australia meet its internationally agreed national targets, and to account for any alternative mitigation measures applied to the uncovered sectors, the approach to setting scheme caps will be to subtract from the indicative national emissions trajectory the projected emissions from sources not covered under the scheme.

It is possible that this calculation could deliver scheme caps that lie outside the gateway range (at either the top of the gateway or the bottom). In that case, the cap would need to be set at the closest gateway point.

Implementation

As discussed in chapter 11, scheme caps would be established in regulations (disallowable instruments). As a result delays in putting in place the regulations extending scheme caps are possible, and would reduce the certainty period over scheme caps.

To ensure that five scheme caps are always in place in line with the Government’s commitment to medium-term policy certainty, a default mechanism will be required.

Setting the default equal to some proportion of the previous scheme cap could be done by formula. As the market would tend to use the previous scheme cap as a guide, this approach would probably be the least disruptive to permit prices. Furthermore, such a default would, on average, have more legitimacy because it would relate to the parliament’s most recent decision rather than a default that was anchored to, say, a gateway that may have been set up to five years earlier.

A reduction in emissions could be built into the default, to give confidence to investors that continued emissions reductions would be required, even if regulations were not in place. A simple default cap that declines at one per cent a year will achieve that outcome.

Timing of initial scheme cap announcements

A number of stakeholders requested that scheme caps be set and announced as early as possible before scheme commencement, such as Origin Energy and BP Australia.  A 2008 scheme cap announcement would provide early guidance for investors. However, it is also critical that the scheme cap decision is made with the most up-to-date information available, including:

•        information about developments in Australia’s international commitments after 2012 (beyond the first Kyoto commitment period)

•        modelling results that take into account more accurate nearer term data and assumptions about emissions, complementary policies and economic data

•        National Greenhouse and Energy Reporting Act 2007 data for 2008-09 (available to the Government in November 2009).

Cap-setting decisions before 2010 would therefore be premature, and the costs of errors could be high, since caps, once set, will not subsequently be adjusted. As a result it is envisaged that decisions on the initial scheme caps and gateways will be made in early 2010.

 



8)      Carbon market

The Carbon Pollution Reduction Scheme will establish a market for greenhouse gas emissions, commonly known as a carbon market. A well-developed carbon market, including secondary and derivatives markets, will enable the economy to reduce emissions in a cost-effective way. [60] The market will provide a reliable price to inform business investment, enabling entities liable under the scheme to obtain carbon pollution permits as and when required and to manage carbon risks.

There are three key questions that must be addressed in regard to the use of permits:

•        Should permits be bankable?

•        Should entities be able to ‘borrow’ permits from future years?

•        Should there be a price cap on permits?

Should permits be bankable?

Banking allows permits to be saved for use in future years. With unlimited banking, permits would not have an expiry date — once issued, they could be used for compliance at any future time.

Box 8.1 outlines banking arrangements in international and other Australian schemes.

Box 8.1: International and other Australian scheme banking proposals

The National Emissions Trading Taskforce [61] and The Garnaut Climate Change Review: Final report [62] recommended unlimited banking. The New Zealand Emissions Trading Scheme also incorporates unlimited banking. [63] However, the Garnaut Final Report noted that, if a transitional price cap is used, permits should not be allowed to be banked between the transition period and the subsequent period. Similarly, the Task Group on Emissions Trading [64] suggested that some limitations on banking might be needed in the early years of the scheme while a transitional price cap is in place.

The European Union Emissions Trading Scheme allows banking between years, but not between Phase I and Phase II. [65] However, banking is allowed between Phase II and Phase III. [66]

There are three broad banking options:

•        allowing unlimited banking

•        not allowing banking in the early stages of the scheme

•        not allowing banking.

A substantial number of stakeholders commented on banking. Of these the large majority were highly supportive of unlimited banking, however, some environmental groups argued that banking should not be allowed as it may lead to emissions targets being breached in later years. A small number of stakeholders also expressed concerns that unlimited banking could raise the price of permits at the start of the scheme.

As with all measures that improve intertemporal flexibility, allowing banking is likely to improve the economic efficiency of the scheme. Banking allows participants to set aside permits for later high demand periods. This advantage is likely to be significant — the total resource costs of meeting a long-term emissions constraint are likely to be lower with unlimited banking than without.

Banking provides greater flexibility both for market participants and, to some extent, for the Government. A more flexible market reduces the pressure on the Government to predict the economy’s demand for permits accurately from one year to the next.

Banking provisions will reduce scheme implementation risks. First, banking is generally likely to lead to an overall price path that is smoother than the non-banking alternative, promoting efficient price discovery. Limiting banking in phases can lead to cyclical pricing behaviour, with prices falling to zero at the end of each phase, as occurred at the end of Phase I of the European Union Emissions Trading Scheme (EU ETS). [67]

Second, if banking is not allowed, permits have a ‘use it or lose it’ property. Liable entities will be less likely to take early action to explore abatement potential if previously obtained permits that become surplus cannot be banked for future use. The absence of banking could therefore slow the pace of adjustment to the emissions constraints.

On the other hand, banking might result in higher initial prices for permits, as noted in some submissions. Setting permits aside for future use reduces current supply (increasing the current price), but increases future supply (decreasing the future price). While this smoothes the price in the long term, the initial price rise makes it more difficult to engineer an ‘easy’ start to the scheme by having relatively low prices.

For this reason, some stakeholders have suggested that banking be disallowed initially while the economy is adjusting to the carbon constraint. However, there are a number of arguments against this:

•        Any step change in prices would only be deferred to the period in which banking is allowed.

•        Prices in subsequent periods would be higher than they would have been had banking been allowed, as more expensive abatement options are pursued (which could have been avoided if less expensive shorter term abatement had been pursued).

•        Disallowing banking between phases could lead to the collapse of the price of permits at the end of the non-banking phase and then a large price step up in the next phase, as occurred in the EU ETS. This cyclical pricing behaviour could lead to less efficient market outcomes and reduce confidence in the system overall.

Current international arrangements allow for banking, that is, eligible international units can be carried over into the next (as yet unspecified) commitment period. If future international arrangements did not allow for banking, there would be a small risk that banking in the scheme would be inconsistent with Australia’s international emissions reduction target.

Overall, the advantages of banking (reducing overall costs, encouraging early and efficient abatement activity, providing greater flexibility to participants and to governments) outweigh the disadvantages (higher early prices than otherwise, and potential inconsistency with international obligations).

Finally, the advantages of banking are greatest if banking is continuous. For these reasons the preferred position is that unlimited banking of permits will be allowed under the scheme (except those accessed under the price cap arrangements - see below).

Should entities be able to ‘borrow’ permits from future years?

Borrowing allows permits to be brought forward from future years. Borrowing can be short term (borrowing only from the subsequent year) or long term (borrowing two or more years in advance).

Box 8.2 outlines international and other Australian scheme borrowing proposals.

Box 8.2:  International and other Australian scheme proposals for borrowing

No Australian proposals or international schemes have recommended unlimited long-term borrowing.

In principle, the Garnaut Final Report allowed for some limited long-term borrowing. This was to be administered by the regulator through the official ‘lending’ of permits from future years (but not exceeding five years in advance), with an obligation to repay the loan at a future date. The regulator would lend only amounts that would not destabilise the current or future market. In this way, the regulator would be an ‘independent carbon bank’ that determines how many permits can be lent, and to whom, based on an assessment of creditworthiness.

The European Union Emissions Trading Scheme has a form of unlimited short-term borrowing. [68] Allowances from the following year are issued early and may be used for surrender in the current year.

The Regional Clean Air Incentives Market (RECLAIM) scheme in the United States has a form of limited short-term borrowing: half of the following year’s units are issued for use in surrender in the current year. [69]

The National Emissions Trading Taskforce recommended a more limited form of short-term borrowing: up to 1 per cent of a party’s obligation could be met by using the following year’s vintage permits. [70]

The Renewable Energy Target [71] , the NSW Greenhouse Gas Reduction Scheme [72] and the Australian Capital Territory Greenhouse Gas Abatement Scheme [73] also have a form of short-term borrowing. Liable entities are allowed a limited shortfall without penalty, as long as the shortfall is made up in the following year.

The Task Group on Emissions Trading recommended that there be no provision for borrowing. [74]

A substantial number of stakeholders commented on borrowing. Of these most were supportive of short-term limited borrowing, however, some stakeholders argued that a greater degree of borrowing should be allowed on the basis that it would provide for greater flexibility, while others argued that no borrowing should be allowed as it may compromise the environmental integrity of the scheme.

Long-term borrowing

The combination of unlimited banking and unlimited long-term borrowing (borrowing two or more years in advance) would result in a ‘carbon budget’ approach. That system would allow a larger proportion of permits to be used in the short term, with corresponding reductions in emissions in later years, if that were the most cost-effective means of remaining within the overall carbon constraint over time. If the integrity of the carbon budget could be maintained, this would be the most economically efficient option.

There are three important disadvantages of unlimited long-term borrowing. First, in the domestic context, it might lead to pressure being applied to the Government to subsequently change the rules. In particular, if too many permits are used in the short term because firms borrow from the future, the Government might be pressured into issuing more permits in the future to avoid problems associated with a subsequent shortage of permits. Industry would have a large incentive to overuse permits (that is, to do less abatement than otherwise) in the short term in the knowledge that the Government may have little option but to accede in the longer term, or risk damage to the economy. Second, long-term borrowing arrangements are not accepted in other schemes and may pose difficulties for linking. Third, if long-term borrowing is allowed under the international climate change framework, this could lead to significant and potentially detrimental delays in the global abatement effort.

Given these risks, the option of unlimited borrowing could undermine the environmental integrity of the scheme. That risk would exist even if borrowing were administered by the scheme regulator in the manner proposed in the Garnaut Final Report. Furthermore, banking in the early stages of the scheme, in anticipation of tighter future caps, would create a store of banked permits that could be used in future years of high demand. That buffer would allow an economically efficient outcome without the need for long-term borrowing. This is why unlimited long-term borrowing is not allowed in any existing scheme and why it is not the preferred approach.

Short-term borrowing

Short-term borrowing (borrowing one year in advance) would promote economic efficiency without the same risks as long-term borrowing. The primary purpose of allowing borrowing between adjacent periods is to prevent price spikes and resultant economic disruption around the final surrender date. Although the frequency and timing of auctions will take into consideration the variation in demand for permits over the course of the year, the risk of price spikes around the surrender date remains, by which time actual emissions for the year and issued permits are fixed. Price spikes can arise either from ‘output surges’, arising from natural variation in the economy, or from speculators ‘squeezing’ a thin pre-surrender date market. By increasing the supply of permits, borrowing from adjacent periods reduces the likelihood of squeezing and gives the market more capacity to cope with output surges.

Under current international arrangements borrowing is not allowed between commitment periods. Short-term borrowing in the scheme will allow for a limited number of future vintage permits to be used in the current commitment period. Where it is expected that there will be net borrowing, the Government will need to manage the difference between scheme design and the international architecture. This could be achieved by purchasing Kyoto units that can be surrendered in the first commitment period to account for the additional emissions associated with borrowed permits. In the second commitment period, the Government would be able to sell surplus Kyoto units because emissions in that period will be lower than they otherwise would have been in the absence of borrowing. This is primarily a concern in the last year of the commitment period. It is not likely to be a problem, as net banking in the scheme is expected over time and it is envisaged that borrowing will be limited to 5 per cent of the next year’s vintage (see below).

The preferred position is that the scheme will permit short-term borrowing.

Form of borrowing

There are several options for limiting the amount of short-term borrowing in the scheme. Few stakeholders commented on this issue.

Some options are to limit borrowing by:

•        allowing only a certain percentage of a party’s obligation to be met using the following year’s vintage of permits (option 1)

•        marking a subset of a year’s vintage as available for use in the previous year’s compliance period (option 2)

•        having the regulator administer borrowing arrangements (option 3).

Option 1 and option 2 deliver an equivalent level of borrowing, as required for output surges. However, option 1 is superior to option 2 in alleviating squeezes (squeezes rely on a shortage of usable units). Because any of the next year’s vintage could be used (in limited quantities) under option 1, it would be difficult to create a squeeze in supply, as that would require the acquisition of the entire year’s allocation. Option 1 is also simpler to implement, as it does not subdivide vintages into different categories.

Option 3 is to have the regulator administer the level of borrowing in accordance with the needs of the market, as proposed in the Garnaut Final Report. The regulator would assess the creditworthiness of the borrower, who would be obliged to repay the debt by providing permits to the regulator at a later date. While the Government would be responsible for setting overall banking and borrowing policy, it would be up to the regulator to decide on the exact amount, timing and terms of the arrangement.

This arrangement is more administratively complex than the other options, which require no assessment of creditworthiness and, as long as the allowance for banking is limited, does not pose a risk to the credibility of the longer term cap. A discretionary approach would also be less transparent and would provide the market with less certainty than one in which rules were legislated. A discretionary approach also requires a high degree of confidence in institutional arrangements, which generally takes time to develop through a track record of sound performance.

For these reasons, the preferred position is to allow liable entities to discharge a certain percentage of their obligation using the following year’s vintage of permits (option 1).

Quantum of borrowing allowance

Unlimited short-term borrowing, like unlimited long-term borrowing, may result in credibility risks for the scheme. For this reason, some limit on short-term borrowing is warranted.

The Green Paper preferred position was to limit the amount of short-term borrowing to 5 per cent of an entity’s obligations. In relation to determining the limit on borrowing, the Green Paper noted that there would need to be careful analysis of the natural fluctuation of emissions in the covered sectors and the allowance of international units into the domestic scheme.

The limit on short-term borrowing should be enough to provide a buffer against potential price spikes arising from output surges (arising from natural variation in the economy) or from financial market participants squeezing a thin pre-surrender date market.

Box 8.3:  Borrowing and the variability in emissions

The limit on short-term borrowing should be sufficient to take account of output surges in the economy. One way to measure output surges is to examine the historic variations in national emissions from sources covered under the scheme.

The broken line in Chart 8.1 represents the trend in cumulative emissions growth from covered sectors (from 1990 levels). This can be viewed as the ‘expected’ growth of emissions from the covered sectors of the economy. The solid line represents the actual cumulative emissions growth from covered sectors (from 1990 levels).

Figure 8.1: Variability in national emissions

Source: National Greenhouse Gas Inventory, Department of Climate Change.

Since 1990, for all covered sectors, emissions have not fluctuated from trend by more than around 2 per cent annually. For borrowing purposes, the relevant years are those in which actual emissions are higher than the trend growth in emissions. This indicates that there has been a surge in the level of emissions (above the level entities may have been expecting), which may leave liable entities with a potential shortfall in permits and require them to borrow from the adjacent period.

The information in box 8.3 suggests that a borrowing limit of 5 per cent would provide a more than adequate buffer against output surges. This limit would also provide some protection against cornering of the market by providing another source of permits beyond the current year. Because any of the next year’s permits can be used, all of these would need to be bought up in order to corner the market.

The cap on borrowing would be in place at the entity level. This would translate through to the scheme as a whole and represent an upper bound for the aggregate borrowing allowed under the scheme.

A borrowing limit of 5 per cent should be sufficient to provide a buffer against output surges and squeezes. This limit achieves market flexibility and smooths price shocks, while avoiding damage to the credibility of the medium-term national target.

Should there be a price cap on permits?

A price cap is a mechanism for setting the maximum cost of compliance under the scheme. In theory, a liable entity would be prepared to pay up to the cap price for a permit. If the price of permits rose beyond that point, the entity would access the price cap rather than buy a permit.

Use of a price cap

An emissions trading scheme controls the quantity of emissions through the issue of permits and leaves the price to be determined in the carbon market. (In contrast, a carbon tax would control the price of emissions and leave the market to determine the quantity.)

The Government cannot control both the price and the quantity of emissions. The Government controls the supply of permits (emissions) and, to the extent that it targets a certain price, it must change the level of supply. In effect, if the Government targets a particular price, the total quantity of emissions is no longer set by the scheme cap.

A price cap, then, is a commitment to loosen the scheme cap if the scheme cap (as currently set) leads to a market price above a certain predetermined level. This occurs because for every use of the price cap an equivalent number of permits are no longer required to be surrendered, effectively increasing the supply of units.

The purpose of the price cap is to set a maximum cost of compliance for liable entities by providing them the option of a cash payment instead of surrendering permits to discharge their liability under the scheme. While the price cap will present a powerful economic influence on prices it is not intended to directly place a ceiling on permit price outcomes in the secondary market or at auction. Prices in the secondary market and at auction will fluctuate depending on market conditions and may even exceed the price cap level from time to time. To allow the smooth operation of the market, the Government does not intend to intervene to stop these kinds of temporary price fluctuations. Notwithstanding these fluctuations liable entities will have certainty over their ultimate maximum costs of compliance.   

Figures 8.2 and 8.3 provide a stylised illustration of the implications of a price cap in a single period of carbon constraint without open international linking. Figure 8.2 shows a scenario in which demand for emissions is relatively low compared to the cap, so the market clearing price is below the price cap and the Government takes no action. Figure 8.3 shows a scenario in which demand for emissions is relatively high compared to the cap, so the market clearing price is higher than the price cap. In that scenario, the Government increases the supply until the price is reduced to the price cap level.

Figure 8.2: Price cap set above market clearing price

Figure 8.3: Price cap set below market clearing price

The combination of unlimited banking and a price cap also adds an intertemporal dimension. If liable entities access the price cap while banking permits for use in future periods, that will create an inventory of permits with which to increase future emissions. Because of this feature, a price cap has the potential to loosen not only the current cap but also future caps.

Box 8.4 outlines some price cap arrangements in Australian and international schemes and in other scheme proposals.

Box 8.4: International and other Australian scheme price cap proposals

Price caps of various forms have been a feature in several emissions trading schemes and proposals.

The National Emissions Trading Taskforce [75] and the Task Group on Emissions Trading [76] recommended that an Australian scheme have a price cap, although both suggested that this arrangement be reviewed over time. The purpose of the price cap was to limit compliance costs and to make them more predictable and stable at the commencement of the scheme.

In the proposed United States emissions trading scheme, a recent revision to the Lieberman-Warner Climate Security Act included an ‘emergency off-ramp’ provision that aims to prevent excessive carbon allowance price rises.

In the McKibbin-Wilcoxen model, a price cap in the form of additional issuance is a permanent feature of the scheme design. [77]

The current Renewable Energy Target, the New South Wales Greenhouse Gas Reduction Scheme [78] , the Australian Capital Territory Greenhouse Gas Abatement Scheme [79] and the Queensland Gas Scheme [80] all have price caps.

The Garnaut Final Report did not support the use of a price cap because of the potential implications for environmental integrity, international linking and the potential risk and cost to taxpayers. The report considered the option of a transitional price control (fixing the price) for the period from 2010 to 2012, but expressed a preference for an unconstrained system coupled with the early acceptance of European Union Emissions Trading Scheme allowances.

The EU emissions trading scheme does not contain a price cap and uses a combination of a high compliance fee and a make-good provision to ensure that caps are met under all circumstances. [81]

The New Zealand Government does not, in principle, support the inclusion of a price cap in the New Zealand Emissions Trading Scheme. However, New Zealand will consider a price cap if its scheme cannot be linked to an international carbon market. This could occur if there is no successor agreement to the Kyoto Protocol or if a suitable international market for emissions is not in place when the New Zealand scheme commences. [82]

Stakeholders were split over the issue of a price cap, with liable parties generally for and financial intermediaries and environmental organisations generally against its use. Those in favour of a price cap argued that it would reduce upward price volatility and reduce implementation risk for participants. Those against the use of a price cap argued that it would undermine the environmental integrity of the scheme and impede the operation of the market at prices above the cap.

The main advantage of a price cap is that it reduces upside price risk for liable parties by capping the cost of compliance under the scheme. It also makes explicit the Government’s policy response in the event of extreme pricing outcomes in the market. In this respect, it can help to promote a smoother transition for those covered by the scheme, and thereby reduce implementation risk.



There are three main disadvantages of a price cap:

•        Accessing the price cap would loosen the emissions cap, reducing the environmental integrity of the scheme. It might even cause a loosening of future emissions caps, further undermining environmental integrity. However, environmental integrity is only seriously compromised if the price cap is set so low that its use is widespread. There is no automatic environmental damage associated with a price cap: the Renewable Energy Target [83] and the New South Wales Greenhouse Gas Abatement Scheme [84] have price caps, but have extremely high levels of scheme compliance through regular surrender of compliance units or certificates.

•        Use of the price cap would increase the likelihood that Australia would have to purchase eligible international units to meet its emissions reduction target. This transfers risks from scheme participants to taxpayers. The precise cost to taxpayers will be a function of the level of use of the price cap, the cost of international units, the impact on auction revenue of relatively reduced scheme prices, and any timing differences between payment of the price cap and the purchase of international units. Because of the potential cost to taxpayers, it is important that the price cap be set at a level which is likely to result in the covered sectors meeting their share of the national effort.

•        A price cap may complicate linking decisions, and might prove to be an impediment to linking with some schemes.

A number of other scheme features also diminish the need for a price cap. Banking and borrowing are weaker methods of constraining the cost of compliance. The proposal to allow unlimited imported international units to be used for compliance in the Australian scheme may also suppress prices, depending on international conditions. However, since the international unit price is uncertain, so too is its value as a precisely known cap on scheme costs.

While there are risks associated with a price cap, the alternative is essentially to commit to enforcing compliance at any cost. While the principle of allowing the market to operate freely is an important one, an emissions trading scheme is a Government-operated system, and some price levels may not be credibly sustained. A price cap can be seen as a way of making explicit the Government’s response should the price of permits rise to a level that imposes a significant and unacceptable cost on the economy.

The preferred position is that the scheme will have a price cap for the period from 2010-11 to 2014-15.

Form of price cap

A price cap can take a variety of forms, but the essential element is that, ultimately, a cash payment in lieu of the surrender of permits could discharge an obligation accrued under the scheme.

A price cap could take two main forms:

•        access to an unlimited store of additional permits, issued by the Government at a fixed price

•        an administrative penalty for non-compliance.

All emissions trading schemes require some form of penalty for non-compliance. If the penalty is in the form of a cash payment in lieu of surrendering permits, it will form an effective price cap in the scheme. Other forms of compliance penalty might not be effective price caps.

The two forms of price cap have the same basic effect of limiting scheme compliance costs, although there are some subtle differences.

•        Payment of an administrative penalty would not be tax deductible under Australian income tax law. Additional issuance, depending on its legal form, could have different tax implications at the point of surrender.

•        An administrative penalty for non-compliance may encourage liable entities to pay higher prices for permits and generate higher levels of compliance within the scheme caps. Many firms place a high value on their reputation as good corporate citizens, and will want to be seen to be complying. Purchase of additional units at a set price would not have those reputational implications.

Some stakeholders in favour of a price cap were supportive of the Government issuing more permits in unlimited quantities at a fixed price. Very few stakeholders favoured the administrative penalty for non-compliance. There were also a large number of stakeholders who wanted a combination of the two in the form of a tax-deductible fee.

A tax-deductible fee and the issuing of additional permits at surrender date for a fixed price are identical in economic substance. Both would be identical for tax purposes, represent the same effective loosening of the scheme cap (as user entities would emit more than otherwise) and be administratively simple to operate. However, issuing additional permits is legislatively simpler to implement and also aligns with the purpose of the price cap mechanism — to explicitly and transparently cap prices at an appropriate level determined by the Government. Furthermore, for reporting purposes, the issuance of permits makes the loosening of the scheme cap transparent.

The preferred position is that the scheme will have a price cap in the form of access to an unlimited store of additional permits, issued by the Government at a fixed price. These permits would not be able to be traded or banked for future use.

Implementation

The permit will be the basic unit of compliance and trade in the scheme. It will be designed to provide a high level of legal and financial certainty.

•        Carbon pollution permits will be personal property.

•        Each permit can be surrendered to discharge scheme obligations relating to the emission of one tonne of carbon dioxide equivalent of greenhouse gas.

•        Each permit will be surrendered under the scheme only once.

•        There will be no power in the legislation to involuntarily extinguish or for a court to order the relinquishment of permits without compensation, except where the permits have been obtained through misrepresentation or fraud.

•        Permits, other than those issued at a fixed price, will be transferable.

•        Permit holders will be entitled to surrender only permits that are entered on the national registry. Legal title will be transferred only by entry in the registry.

•        The creation of equitable interests in permits will be permitted, as will taking security over them.

•        Each permit will have a unique identification number and will be marked with the first year in which it can validly be surrendered (its ‘vintage’). It will not have an expiry date.

•        The permit will be represented by an electronic entry in the registry, rather than by a paper certificate.

Services provided in relation to permits will be similar to those for financial products, such as shares and debentures. Those services are expected to include the provision of trading advice, brokerage services, trading platforms and support services. It is expected that derivatives over permits will be financial products for the purposes of the Corporations Act 2001 as it currently stands, and there is no proposal to change this.

Permits, like other financial products, could also be the subject of market misconduct, including market manipulation and insider trading. Market manipulation includes manipulation of the auction process (for example, through collusion) and of prices in the secondary market. There is also the possibility of cornering the market for permits close to the time for surrender. To address these risks the Government has decided that permits and Kyoto units will be regulated as financial products under Chapter 7 of the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 with appropriate adjustments to fit the characteristics of permits and avoid unnecessary compliance costs, and relying on its own constitutional power. They will also be subject to the economy-wide competition provisions in the Trade Practices Act 1974 .

 



9)      Taxation issues

The introduction of an emissions trading scheme has a number of implications. Permits to emit carbon will be a valuable instrument and their acquisition, possession and disposal will create obligations under the taxation system.

In theory the Government could make no changes and rely on generic provisions in taxation law to govern any taxation obligations arising under the emissions trading scheme.

While it is intended that the design of the tax system creates minimal distortion around permit purchases, uses or sales, in some cases the generic tax requirements may create incentives to categorise the purchase or holding of permits in certain ways to reduce tax liabilities. In some instances, it may create an incentive to purchase, hold or dispose of permits at a time or in a way that the business would not otherwise have done but for the advantageous tax treatment the action would receive.

This chapter of the RIS looks at the treatment of permits under the current taxation arrangements and whether an amended system would be an improvement on the generic provisions.

The main objectives are pursued when considering the merits of different taxation arrangements:

•        The taxation arrangements should not distort incentives surrounding business decisions to acquire, hold or dispose of emissions permits.

•        The taxation arrangements should be as simple as possible, minimising compliance and administration costs.

•        The taxation arrangements should provide business with a consistent tax treatment.

•        The proposed taxation treatment will not impose any additional compliance costs on consumers.

•        The proposed taxation treatment will not place an unreasonable administrative burden on the Government.



The current taxation arrangements

For a taxpayer carrying on a business or undertaking other assessable income earning activities, the existing income tax law would recognise the cost of acquiring permits.

The particular treatment and provisions that would apply in any particular case would depend on the entity’s purpose in holding a permit, both at the time of purchase and while the permit is held. For example, an entity could purchase a permit:

•        to meet an obligation under the Australian scheme

•        as part of its trading portfolio as trading stock

•        to surrender voluntarily as part of a marketing campaign

•        as an investment.

Application of the current tax law

While the relevant income tax principles are well established, the application of those principles to particular circumstances may be uncertain. Considerable complexity may arise for taxpayers because a permit can be treated differently when held by different taxpayer types (for example, liable entities and entities that hold permits as trading stock) or when held by the same taxpayer for different purposes (for example, a liable entity holding permits for surrender and other permits for sale).

Uncertainty could also arise if a liable entity purchases permits for use, claims a deduction and then realises that too many permits were purchased. In this case the excess permits may be banked until required. If a permit remains banked over a number of years, there may be a change in the purpose for holding the permit. This could affect the tax treatment of the permit. In creating uncertainty, the operation of the current law could lead taxpayers to use financial intermediaries to hold permits, purchasing them only when needed. For some taxpayers, this may not be the most efficient method of meeting obligations under the scheme or managing risk. The following sections illustrate how the tax treatment can change where circumstances change. 

Permits purchased to meet an obligation

Where an eligible compliance permit is purchased to meet an obligation under the scheme, the cost of the permit may be deductible under the general deduction provision of the income tax law. However, it is not clear when the deduction would be available. The cost could be deductible at the time:

•        the permit is purchased

•        an obligation under the scheme legally arises

•        the permit is surrendered.

The tax treatment of a permit could influence the decisions of an entity to buy or sell a permit. The existing tax law allows a deduction at the time of purchase. This provides an incentive for an entity to acquire permits. If the permit is sold the proceeds would be included in assessable income. Allowing a deduction in a different year to that in which the proceeds from sale are treated as income could provide a disincentive for the entity to sell a permit. That disincentive to sell could then reduce market liquidity. This could then lead to a situation where permits are not available to entities for which they have the most value, reducing the cost effectiveness of the scheme.

Permits purchased and held as trading stock

The trading stock regime can be thought of as a reconciliation process for stock on hand at the end of the income year. Where a taxpayer purchases trading stock, the tax law allows a deduction at the time of purchase. However, the trading stock regime also recognises any stock held by the taxpayer at the end of the income year in which the stock was acquired. The value of that trading stock is included in the taxpayer’s income as trading stock income. Trading stock held at the end of an income year can be valued at cost, market value or replacement value. Any proceeds from the sale of trading stock are included in a taxpayer’s income as trading stock income. Taxpayers who might hold a permit as trading stock are likely to include banks and other financial intermediaries.

Permits purchased for marketing purposes

A business entity may purchase and voluntarily surrender a permit for promotional or marketing purposes; for example, to market itself as ‘green’ or to reduce its carbon footprint when there is no legal requirement to do so.

The cost of a permit purchased for marketing or promotional purposes may be deductible in the same way as other marketing costs. However, as is the case for the timing of a deduction arising from a permit used to satisfy an obligation under the scheme, there is uncertainty about the time at which a deduction would be available to a business entity for a permit acquired and surrendered for marketing purposes.

Proceeds from the sale of a permit acquired for promotional or marketing purposes would be taken into account in determining the seller’s assessable income.

Permits purchased for investment

Where a permit is purchased for investment purposes, the cost of the investment would be taken into account in determining any gain or loss on the disposal of the permit.

A permit does not provide an income stream while it is being held, with the only return being obtained by selling the permit for a profit. If a taxpayer enters into an isolated business or commercial transaction with the objective of acquiring an asset to make a profit from the disposal of that asset, any profit is assessed as ordinary income, rather than as capital gains. [85] Consequently, it is very unlikely that a gain from a permit held for investment purposes would be assessed under the capital gains tax (CGT) provisions.

Interaction with the GST framework

Under normal goods and services tax (GST) rules, different types of transactions under the emissions trading scheme will be treated differently. For instance, payments for auctioned or purchased permits would be subject to GST while the provision of free permits and the surrender of permits would not be not be subject to GST.

While a separate GST framework could be established for transactions involving permits, there is no reason to suspect that the general provisions would result in distortions or incentives to acquire, hold or dispose of permits in a particular manner. Moreover, creating separate GST arrangements for the emissions trading scheme would create anomalies in the treatment of different transactions between emissions trading scheme transactions and other transactions. 



Options for the income tax treatment of permits

Two options that are available for the tax treatment of permits are:

•        to allow the current tax law to apply

•        to amend the tax law to introduce specific provisions for the income tax treatment of permits.

Despite the considerable complexity and uncertainty in the application of the current tax law, it may be argued that, if applied appropriately, the current law would generally lead to the same outcomes regardless of why the permit is held, and so would largely meet the objective of tax neutrality.

However, the complexity of the current tax law, with its requirement for careful characterisation based on individual circumstances and the resulting uncertainty that can arise for taxpayers, could create undue compliance costs for taxpayers and administration costs for the Government. While the uncertainty could be managed by a combination of changes to existing law, legal processes to test the treatments in the courts and rulings by the Australian Taxation Office (ATO), the clarification process would be piecemeal, slow and could still result in considerable uncertainty.

Development of discrete legislative provisions for the tax treatment of permits

An option for recognising eligible compliance permits which would overcome complexity and uncertainty is to develop new provisions within the tax law that would apply specifically to those permits. Such provisions would provide the same general tax outcomes as existing law, while reducing the uncertainty and complexity arising from the application of different provisions in the current law. New provisions would:

•        allow a deduction for expenditure incurred for the purchase of a permit

•        include any proceeds from the sale of a permit in assessable income.

An important tax consideration is the time at which the deduction for the purchase of a permit is realised.

Allowing a deduction in the income year a permit is purchased might not achieve the desired neutrality and could encourage entities to hold more permits than would be optimal. The potential for a temporal gap between the deduction for the cost of the permit and the recognition of any income from the disposal of a permit could result in permits being used for tax minimisation. If such a gap existed, a tax benefit could arise because the present value of a deduction recognised in an earlier year is greater than the present value of the deduction in a later year.

A tax-neutral outcome is achieved by delaying the effect of the deduction until the year the permit is surrendered or sold. This approach would not bias an entity’s decision to bank or use permits. Similarly, it would ensure that there are no adverse tax consequences from using or selling a permit.

Where a permit is purchased and surrendered or sold in the same income year, a deduction would be allowed in that year. If a permit is banked, the effect of the deduction will be deferred until the permit is surrendered or sold. Any proceeds from the sale of a permit would be included in assessable income in the year of sale. To achieve this outcome, a rolling balance method will be adopted to assess income derived from permits (see box 9.1).

Box 9.1: The rolling balance method

Under the rolling balance method:

•        the cost of a permit would be deductible when the permit is acquired in the same year in which the permit is surrendered or sold

•        the proceeds from selling a permit would be assessable in the same income year in which the permit is surrendered or sold

•        any difference in the value of permits held at the beginning of an income year and at the end of that year would be reflected in assessable income, with

-       any increase in value included as assessable income

-       any decrease in value allowed as a deduction.

The rolling balance would use principles similar to those used in the trading stock regime.

The effect of the rolling balance would be that any expenditure on permits would only affect assessable income in the year in which the permit is surrendered or sold. Therefore, if a permit was purchased and surrendered in the same income year, the cost of the permit would reduce the assessable income in that year. However, if a permit acquired in an income year was banked, the cost of the permit would not affect the assessable income in that year.

Moreover, entities will be given the choice of adopting a market value or historical cost approach to valuing permits within the rolling balance method (see box 9.2).

Under the discrete legislation the capital gains tax provisions of the tax law would not apply to transactions involving permits. In addition, private or domestic expenditure on permits, including the purchase of permits for the purpose of voluntary retirement, would not be deductible (as would be the case under the current legislation).

The benefits of this approach include:

•        a simple and consistent tax treatment giving taxpayers more certainty

•        removing the need to characterise the nature of the entity holding the permit and the reason for holding

•        removal of tax minimisation opportunities arising because there are different types of holders

•        minimising administration costs for the ATO.

This approach would achieve the tax objectives outlined for the scheme. In particular, business expenditure on permits would be treated consistently, regardless of why the permit was held, thereby satisfying the tax axioms of simplicity, equity and efficiency.

Box 9.2:  Valuation method

An important consideration in the use of a rolling balance method is the way in which permits should be valued under the rolling balance. They can either be valued at the original cost of acquisition or at their end of year market value.

There is no clear policy rationale for allowing one valuation method over another.

Valuing the permits at their historical cost will require taxpayers to record the purchase price for each permit until it is surrendered or sold. In some cases this may be a number of years later and may require keeping records for longer than the general tax law requirement of five years (but maybe longer in some circumstances).

Where permits have been banked and the value of those permits has increased, the historical cost approach may create an incentive to hold the permits when there are other taxpayers who may value the permits more highly. This is because a deduction would only be available for the purchase price of the permits (not the market value). There will be a disincentive to sell the permits because the taxpayer would have a large gain in assessable income where there may be a large difference between the selling and purchase price.

On the other hand, under the market value approach, increases in the value of the permits would be included in assessable income whether or not the permits were sold.

The market value approach may lead to the taxation of unrealised gains as taxpayers are assessed on any change in price of permits on hand. This would only be an issue if there were substantive increases in the value of permits over the income year. However, due to the fact that permits have no expiry date, that banking and borrowing rights will exist and that the end of the income year will not coincide with the reconciliation of emissions and permits, it is not expected that there will be significant increases in permit values around the end of the income year.  

Taxpayers may prefer one valuation method over another depending on their existing business practices or systems. Requiring taxpayers to use the market valuation method may impose additional compliance costs. However, it is not expected that there will be large compliance costs as market values should be readily available at low cost to the public as a consequence of the regular auctions of permits and the expected secondary market for permits. Also these costs should be relatively transitionary. 

Consultation identified that stakeholders would prefer flexibility to choose a valuation methodology. There are a number of advantages for providing taxpayers with the capacity to elect their valuation method. It would allow taxpayers to elect a method which is most suited to their commercial situation. It also enables taxpayers the flexibility to change if circumstances change while transitioning to the scheme.

Providing ongoing flexibility may create opportunities for tax arbitrage, would introduce a high compliance burden for taxpayers as well as increasing administrative and compliance costs for the ATO. 

Therefore, taxpayers will be allowed to make a one-off election whether to use historical cost or market value to value all permits on hand. Taxpayers will be able to change methods once during the first five years of the scheme and not thereafter. This transitional option allows taxpayers to adjust to the scheme.  This approach allows the taxpayer to choose the method which aligns best with their existing tax and accounting practices and is likely to minimise compliance costs for the taxpayer. Providing taxpayers a choice is at a limited cost to the simplicity of the rolling balance method. It will make the tax legislation more complex and increases interpretative and administration complexities for the ATO.

On balance, the preferred approach is to allow taxpayers to elect the valuation option (market or historic value) for a transitional period of five years. While it is recognised that allowing permit holders choice in methodology will involve some extra complexity in the tax law, this approach is preferred due to the flexibility it gives permit holders.

Consultation

The Treasury and the Department of Climate Change undertook extensive consultation with key industry professionals on the design of the taxation treatment of permits.

Consultation included:

•        a pre-policy discussion

•        information sessions in Sydney, Melbourne, Perth and Brisbane following the release of the Green Paper

•        an in-depth consultation meeting to consider any technical and practical implementation issues.

Stakeholders were broadly comfortable with the broad policy framework for the taxation treatment of permits outlined in the Green Paper.

Key issues raised in consultation were around the timing of deductions, valuation methodology, taxation of free permits, and GST.

Stakeholder concerns around these issues and alternative solutions were considered in the development of the taxation treatment of permits. 

Stakeholders considered that the Green Paper preferred position to delay the deduction until when the permit is sold or surrendered may create a timing mismatch.  Stakeholders also argued that exempting free permits from tax was necessary to prevent timing and cash flow disadvantages. 

As permits can be surrendered at any time throughout the year, for which an upfront deduction is available, no substantial timing disadvantage is evident as entities have the choice to match their deductions for the cost of their permits to their actual emissions. 

Cash flow issues will arise only if firms choose to bank free permits. Further, an entity could ameliorate any cash flow issues by selling permits on the secondary market.

Some argued that businesses could be required to pay tax on their free allocation of permits before they had an opportunity to use the permits. 

Coal-fired electricity generators will receive free permits to partially ameliorate the impact of the Scheme on their asset values. Direct assistance for coal-fired electricity generators will be provided by free permits spread equally over five years as a form of transitional assistance. This assistance is not intended to affect the production decisions of coal-fired electricity generators. Rather it is provided to offset some of the losses in their asset values. Therefore it is appropriate that assistance for these firms be taxed in an equivalent manner to other government assistance

However, a ‘no disadvantage’ rule will be included in the tax legislation to ensure that emissions-intensive trade-exposed entities allocated free permits will not be disadvantaged if the surrender date following the receipt of free permits falls in the next income year following the year in which the permits were received. Direct assistance to emissions-intensive trade-exposed industries will be on an annual basis and is intended to minimise the impact of the scheme on the decision on whether to continue to produce in Australia as emissions-intensive trade-exposed industries are price takers in an international market.

Therefore, the Green Paper positions to defer deductions until when the permit is sold or surrendered and to tax free permits on receipt are recommended to be retained.

Stakeholder views were taken into account in developing a transitional option for calculating values of permits held in the rolling balance. Taxpayers will be able to elect a valuation method, with taxpayers able to change valuation methods once during the first five years of the scheme. This option was developed in response to stakeholders seeking a flexible approach for valuing permits at either historical cost or market value.  

Some stakeholders raised concerns that the application of the normal GST rules would lead to uncertainty about the GST treatment of various types of Carbon Pollution Reduction Scheme transactions. It is proposed to amend the GST law to characterise permits as personal property (and not rights over real property) for GST purposes to provide certainty. While establishing a discrete set of GST rules for CPRS transactions (as proposed by stakeholders) would also increase certainty, this would add to the complexity of the GST law and create a precedent for developing special rules for other classes of transactions.

Some stakeholders were also concerned that the application of the normal GST rules would increase cash flow and compliance costs, and result in unrecoverable GST on business inputs due to the input taxed treatment of financial derivatives of permits. These concerns were noted but were not considered to warrant special treatment as cash flow and compliance costs are a normal feature of the GST system. It was considered that introducing special rules such as GST-free treatment (as proposed by stakeholders) to address cash flow and compliance cost concerns would undermine the broad-based nature of the GST system, result in different GST treatments for like transactions in the economy, lead to calls for other transactions to be exempt and add to the complexity of the GST.

Preferred option

Income tax

The preferred approach is to introduce discrete legislative provisions for the income tax treatment of permits. The legislation would make use of a rolling balance method and allow permit holders to elect whether to use historical or market prices to value permits in the rolling balance.

As outlined, using the generic income tax arrangements while generally resulting in the appropriate tax treatment of permits would be more complicated resulting in additional compliance and administration costs for taxpayers and the ATO. The preferred approach should result in appropriate tax outcomes while avoiding the need to characterise the purpose for obtaining permits and would be straightforward for taxpayers and their agents to use.

GST

The preferred approach is to make an amendment to the GST law to characterise permits as personal property rights (and not rights over real property).

This will promote certainty about the GST treatment of particular type of CPRS transactions, including the GST treatment of cross-border transactions.  It will also ensure that the application of the GST normal rules to CPRS transactions will deliver the GST outcomes stated in the Green Paper, including generally not leading to embedded tax for entities.

Other issues

In addition to the income tax treatment of permits, there are other areas where the tax and accounting system will interact with the emissions trading scheme.

The treatment of free permits

One option for the provision of assistance to affected parties is to provide ‘free’ permits or cash payments. Under general taxation principles, benefits which are directly related to the business or income-producing activity should be included in assessable income irrespective of whether the benefit is in the from of cash or assets. As a result, where Government provides assistance to industry, whether in the form of a cash payment or other grant, such income is included in a business’ assessable income and is taxable.

An alternative approach would be to exempt the issue of permits from the tax system which would result in no tax being paid on this assistance. While this would increase the value of assistance being provided to the affected parties, it would create distortions in market for permits.

If free permits were exempt from taxation or taken to have a zero cost an unnecessary distortion may be created. Over time, the price of permits (both free and purchased) is expected to rise. Not taxing the permit would create an incentive to hold the free permit when there are other taxpayers who may value the permit more highly. Also if a liable entity were able to choose between using a purchased permit it had banked and a free permit it had banked, it may choose the purchased permit because of the deduction it could claim for that permit’s use. This would mean that the tax treatment of a permit would undermine the environmental effectiveness of the scheme.

Moreover, exempting scheme-based assistance from the tax system would be inconsistent with general tax principles and would place additional strain on other tax payers and the community (who would have to fund this tax expenditure). This option is not preferred.

The interaction with accounting rules

The accounting treatment of permits and transactions under the emissions trading scheme will be important to the financial accounts of many businesses. It is therefore important that appropriate accounting standards are in place to ensure that comparable and reliable information is provided to investors.

There is a process underway to push for the development of such accounting standards at an international level. Australian accounting standards are international financial reporting standards and the preferred option is for the development of an international standard rather than develop a specific domestic accounting standard. This should ensure globally consistent accounting policies in this area.

Again it is envisaged that the Australian Accounting Standards Board (who develop Australian accounting standards) will monitor the need an Australian standards ahead of or instead of international standards.



10)    Transitional issues

The auctioning of carbon pollution reduction permits will generate significant revenues for the Government. The Government has already committed to using these revenues to assist in the implementation of the scheme and smoothing the transition for business and households to a world with a positive carbon price. This chapter outlines these measures. It does not consider the merits of these programs as they are not ‘regulatory’ in nature.

The chapter also considers the nature of existing state based arrangements to reduce carbon emissions and how the introduction of an emission trading scheme will impact on those schemes.

Transitional assistance

The Government has committed to using revenue from the scheme to assist with the introduction of the Carbon Pollution Reduction Scheme and smooth the transition to an economy with a positive carbon price. These assistance measures fall into four broad groups: assistance for emissions-intensive trade-exposed (EITE) activities, assistance to strongly affected industries, the climate change action fund and household assistance measures. Funding for the assistance will be sourced from both permit revenue and budgetary appropriations. In total, it is expected if all permits were auctioned, the value of permits would be around $11.5 billion per year. The Government will not realise all of this revenue as some portion of be freely allocated to emissions intensive trade exposed firms and strongly affected industries (see below). Box 10.1 discusses the distributional impacts of this funding.

In all, the objective of the transitional assistance package is to smooth the adverse impacts associated with the introduction of a carbon constraint under the scheme. The impacts of the scheme will not be felt equally across the community. Certain businesses (for EITE businesses who are constrained in their capacity to pass on costs) and lower income households would be likely to face more acute impacts from the scheme in the absence of any assistance measures.

In the case of business, the aim of the assistance is to allow them to adjust to the introduction of the scheme in a more orderly manner and reduce the likelihood of adverse environmental impacts with businesses relocating offshore (to avoid the carbon price), which is commonly referred to as carbon leakage. In the case of households the aim is to moderate some of the higher costs associated with the introduction of the scheme.

Box 10.1: Distributional impacts

The combination of assistance packages will clearly benefit some portions of the community more than others. A key consideration when looking at who benefits is to consider what would have happened with permit revenue in the absence of the assistance schemes. While the CPRS is not a tax as such, in the absence of the assistance measures, revenue raised from the sale of permits could be directed to other Government expenditure or to offset other revenue sources if there was to be no net gain to the Budget. While this could conceivably benefit any combination of social groups or businesses, for the purposes of looking at the distributional impacts of the assistance schemes it is possible that the revenue would be distributed evenly throughout the community.

If this assumption were true, the key beneficiaries of the assistance packages will clearly be those receiving assistance. Those who do not receive assistance will be worse off relative to the world in which permit revenue is shared evenly amongst the community, but it is important to recognise that for the most part these are households and businesses who will incur fewer costs as a result of the scheme.

The introduction of the scheme will have a significant impact on the prices paid by households for many goods. The most significant price rises will be associated with energy prices, with retail electricity prices modelled to rise by around 20 percent in the five years following the scheme. [86] As discussed in chapter 2, the average price impacts, across all households, is estimated to be 1 per cent in 2010, with lower income households generally incurring a slightly higher price impact. [87] For instance, the price impact for single pensioner households is estimated to be 1.3 per cent. The household and community assistance packages are generally aimed at countering the adverse distributional impacts of the scheme. As a result the assistance package is primarily targeted at pensioners and low income households. Other (middle and upper income) households will receive more limited assistance from the package.

The climate change action fund will assist communities and businesses particularly affected by the CPRS. While it is reasonable to assume the communities with certain characteristics (those heavily dependant on emissions intensive industry) will benefit, until decisions are actually made concerning who will receive assistance it is not possible to describe the distributional outcomes of this assistance. Similarly for the business component of the scheme, at this stage it is not possible to describe who will benefit from the scheme.

In looking at the EITE assistance, clearly the beneficiaries will be emissions intensive trade-exposed industries. Again it is important to recognise that these industries incur significant costs as a result of the scheme, with significant constraints on their ability to pass on their carbon costs to the consumers of their products. So while they are better off relative to a world with a CPRS and no assistance, relative to a world with no CPRS, they will still incur a net cost.

In the case of the ESAS, the beneficiaries will be the most emissions intensive coal fired power generators. Other less emissions-intensive power generators will not receive assistance but should be in a position to pass on most of the costs associated with the scheme (and so will not be adversely affected).

The impact on taxpayers will to depend to a large part on the size of the assistance package. If the size of the expenditure programs (the CCAF and household assistance) exceeds the revenue raised as part of the auction sales, the additional funding will need to come from existing or new taxation thereby imposing a cost on taxpayers.

Assistance to emissions intensive trade exposed activities

The introduction of a carbon constraint under the carbon pollution reduction scheme will place a price on greenhouse gas emissions and will adversely affect industries which have large emissions per unit of output (that is, emissions intensive activities), and limited capacity to pass on their carbon costs. Although many businesses will be able to pass on these costs to customers (because their competitors are affected in a similar manner), some businesses will be unable to pass on costs because they are price takers in world markets, and compete with some producers who may not face comparable carbon costs..

In this case, the existence of a carbon price in Australia could result in emissions intensive trade exposed entities leaving Australia (or choosing not to establish in Australia), so called ‘carbon leakage’. If this production occurred in jurisdictions with a similar or worse emissions intensity, Australia would be imposing costs domestically which may not produce an environmental benefit.

To reduce the likelihood of carbon leakage, and to provide transitional assistance to companies to adjust to the scheme, the Government will provide assistance to EITE industries. This assistance will be in the form of free permits and will be revisited when there is broadly comparable carbon constraints applying internationally. The design of the assistance scheme will allow the provision of assistance to new industry entrants on the same basis as for existing businesses.

Assistance to EITE companies will be provided on an activity basis rather than an industry or company basis. Many companies undertake a range of activities some of which will be EITE and some will not. To ensure that assistance is most effectively targeted at the activities that are most at risk of carbon leakage, assistance will be provided to companies based on the particular activities they undertake, not on industry in which they reside or some company wide measure of emissions intensity.

To ensure that those receiving EITE assistance continue to have an incentive to reduce emissions, it is envisaged that rates of assistance for different activities will be set out in regulations. Companies will receive a set number of permits per unit of production. They will still be obliged to surrender sufficient permits to cover their actual emissions.

The rate of assistance will depend on the emissions intensity of the relevant activity. More emissions intensive activities will receive greater levels of assistance although the assistance provided will not completely shield EITE businesses from the permit costs associated with the scheme. The level of assistance is likely to decline over time as the number of permits (and hence level available for EITE assistance) declines.

The EITEs assistance scheme will run until measures which impose a carbon price broadly comparable to that under the CPRS are introduced in competing countries.

Assistance to strongly affected industries

Assistance to strongly affected industries will be provided via the Electricity Sector Adjustment Scheme (ESAS). The ESAS is aimed at assisting certain electricity generators (coal-fired powered stations) who will be adversely affected by the introduction of carbon price. While many electricity generators will be able to pass on the costs associated with the purchase of carbon permits (to cover emissions), some generators who are low in the ‘merit order’ will be less able to pass on costs. [88] As a result, they are likely to incur significant costs as a result of the introduction of the scheme including significant impacts on the values of established assets.

The ESAS will provide assistance over the first five years of the scheme to established coal-fired generators who are the most emissions intensive, with the highest impacts on their asset values over time. Assistance will be provided on an asset by asset basis — though eligibility for assistance and the amount of assistance provided, will be determined prior to the commencement of the scheme, and will not be contingent on production. This decouples assistance from ongoing production decisions and would not provide an incentive to continue in operation when unprofitable to do so. Assistance will be provided in the form of free permits.

The Climate Change Action Fund

The Climate Change Action Fund will be established to smooth the transition for businesses, community sector organisations, workers, regions and communities to an operating environment that includes a price on carbon. The Climate Change Action Fund (CCAF) will provide assistance by addressing the distributional impacts of the scheme and correcting persistent market failures that impede the uptake of lower emission technologies and processes. The CCAF will run for five years commencing in 2008-09.

The CCAF will comprise four streams of activity:

Stream 1:  Information

This stream will focus on informing small to medium sized enterprises, non-ETIE liable entities, industrial businesses more broadly and the community services sector about the operation of the scheme and how they can manage the expected financial impacts. It will also assist in addressing information failures that impede the uptake of low emission practices and processes and energy efficiency opportunities.

Stream 2:  Capital investment in climate change.

This stream will be comprised of three measures to provide funding for low-emission technologies and high-energy savings projects:

•        Small Business Capital Allowance to assist investment in energy efficiency equipment (eg hot water; insulation; lighting; motor and drives; combined heat and power; heating, ventilation and air conditioning; and refrigeration equipment) that meets established energy saving criteria. Priority will be given to those small businesses that are not eligible for other forms of assistance or receive the lowest rate of assistance under the EITE policy.

•        Community Organisation Capital Allowance to provide small community organisations with assistance to invest in energy efficiency equipment that meets established energy saving criteria.

•        Innovation in Climate Change to provide competitive grants funding for low emission technologies, production methods, supply-chain improvements or products; and high energy savings projects with long pay back periods. Priority will be given to those businesses that are not eligible for other forms of assistance or are eligible for the lowest rate of assistance under the EITE policy. Applications would also be received from large community organisations and local government

Stream 3:  Structural adjustment provision for workers and communities

The Green Paper indicated that while existing welfare safety net support mechanisms and other government measures provide a means to assist affected workers, regions and communities disproportionately impacted by the scheme, additional support may be required in some cases. To respond effectively to these situations this stream will support workers, regions and communities where a clear and sizeable burden is identified, or is likely to occur as a direct result of the introduction of the scheme.

Stream 4:  Coal Sector Adjustment

Underground coal mine operations with high fugitive emissions have been identified as an industry sub-sector that will not be eligible for other forms of scheme assistance, and that will be significantly affected by the introduction of the scheme. Initially adjustment assistance will be provided to affected coal mining operators to promote the investigation and implementation of emissions abatement technologies. If abatement opportunities are not available then other structural adjustment assistance would be provided including worker retraining and relocation expenses.

Household assistance measures

The Government has also committed to a more general household assistance package. The package is aimed at cushioning the impact of price increases associated with the emissions trading scheme on households. It includes:

•        Increased payments, above automatic indexation, to people in receipt of pensioner, carer, senior and allowance benefits and to provide other assistance to meet the overall increase in the cost of living flowing from the scheme.

•        Increased assistance to other low-income households through the tax and payment system to meet the overall increase in the cost of living flowing from the scheme.

•        Assistance to middle-income households to help them meet any overall increase in the cost of living flowing from the scheme.

•        Additional support through the introduction of energy efficiency measures and consumer information to help households take practical action to reduce energy use and save on energy bills so that all can make a contribution.

With the exception of the energy efficiency measures which are likely to run for five years, the impact of the other assistance delivered by the pension and tax and payment system will be ongoing.

The Government has also committed to offsetting (through a cent for cent reduction in the excise rate) the impact of the emissions trading scheme on fuel prices. This measure will be reviewed after three years.

Existing measures

At the State level, two major market-based emissions reductions measures are operating in the electricity market.

The first market-based measure is the New South Wales Greenhouse Gas Reduction Scheme (GGAS) 1 , which began on 1 January 2003 and was originally scheduled to operate until 2012. In November 2005, the New South Wales Premier confirmed his Government’s commitment to extend GGAS to 2020 and beyond. The aim of GGAS is to reduce greenhouse gas emissions associated with the production and use of electricity in New South Wales from 8.65 tonnes of CO 2- e per capita in 2003 to 7.27 tonnes of CO 2- e per capita by 2007, and to maintain that level until 2020.

The second market-based scheme is the Queensland Gas Scheme, which commenced on 1 January 2005 and is scheduled to operate for 15 years. Under this scheme, Queensland electricity retailers and other liable parties are required to source at least 13 per cent of their electricity from gas-fired generation. The Queensland Government subsequently revised the target to 15 per cent. Gas-fired generators in Queensland are able to create certificates for every megawatt hour of electricity that they produce.

The Queensland Gas Scheme aims to diversify the state’s energy mix, encouraging greater use of gas and the development of new gas sources and infrastructure in Queensland. An associated benefit is the reduction of greenhouse gas emissions from the Queensland electricity sector.

With the introduction of an emissions trading scheme, the rationale for these schemes is diminished. Both schemes have the objective of reducing emissions from the power generation sector. The emissions trading scheme should meet this objective in a manner that places least overall burden on the economy. [89]

Ultimately, whether or not to cease the existing schemes is a decision for the State governments concerned. New South Wales has indicated that it would terminate the GGAS in the event that an emissions trading scheme is established that would result in a similarly stringent emissions reductions. To this end, it has released a discussion paper considering transition options. The Queensland Government has made no decision to halt the Queensland Gas Scheme in the event that a national emissions trading scheme is established. To assist with streamlining the number of schemes in operation (and reducing the compliance costs on affected entities) the Australian Government will discuss transitioning out of state based schemes with the relevant jurisdictions. The form or magnitude of any assistance provided to the states is yet to be determined.

There is the possibility that some particular projects would be disadvantaged by the replacement of the state based schemes with the emissions trading scheme. This would happen where the project is less profitable under the emissions trading scheme than the state based scheme. For example, the Queensland Gas Scheme could require additional investment in gas fired power generation which would not be efficient under the emissions trading scheme. It is expected that the cap on emissions under the emissions trading scheme is likely to result in a scheme that is at least as stringent as the existing schemes. In discussions surrounding the phase out of the state scheme, the Australian Government would also discuss arrangements for any (exceptional) projects which are likely to be worse off under the emissions trading scheme.

 



11)    Governance arrangements and implementation

This chapter of the RIS considers the governance arrangements for the Carbon Pollution Reduction Scheme (the scheme) and the key steps in the implementation of the scheme. Sound governance arrangements are critical in delivering the scheme efficiently, effectively and accountably.

Roles of Parliament, the Government, the Minister, the regulator and the advisory committee

Key roles

Governance arrangements require the allocation of responsibility for particular roles that will need to be performed in relation to the operation of the scheme. Key roles include:

•        setting the medium- and long-term national emissions reduction targets

•        setting the emissions trajectory (including the scheme caps and gateways) to meet the national targets over time

•        deciding which sectors should be covered initially by the scheme, and on what terms

•        deciding which additional sectors should be covered as the scheme develops, and on what terms

•        setting out principles and criteria for assistance to emissions-intensive, trade-exposed industries and strongly affected industries

•        deciding whether particular entities are eligible for such assistance

•        deciding rules for the banking and borrowing of carbon pollution permits

•        applying any banking and borrowing rules to individual cases

•        allocating permits, including handling auction proceedings

•        deciding which methods should be allowed for measuring and reporting emissions

•        receiving emissions data and assessing each liable entity’s obligation to surrender eligible compliance permits

•        monitoring, facilitating and enforcing compliance with the scheme

•        operating a registry to track the issuance, holding and transfer of eligible compliance permits

•        determining the nature and extent of linking between Australia’s Carbon Pollution Reduction Scheme and other schemes operating internationally

•        providing education about the scheme

•        reviewing the performance of the scheme and the effectiveness of scheme settings.

Responsibility for particular roles

Responsibility for particular roles may be allocated to:

•        the Parliament, by setting out decisions, or the rules for making decisions, in legislation

•        the Government, encompassing the cabinet and the minister with primary responsibility for the scheme

•        a statutory body established to administer the scheme, ‘the regulator’

•        advisory or review bodies.

Submissions received in response to the Green Paper

The submissions to the Green Paper indicated overwhelming support for an independent regulator, for integrity in decision-making, transparency, certainty and predictability.

Some stakeholders indicated a preference for establishing a ‘carbon bank’, meaning an institution modelled on the Reserve Bank of Australia, or simply a regulator with independence for making decisions on individual matters in accordance with the legislative criteria and which was not subject to direction of the Minister on individual matters. Professor McKibbin suggested that emissions trading policy should be designed like monetary policy with a central carbon bank managing the short-term price of carbon, given a pre-committed Government policy on the long-term goals for the Australian economy. Australian Climate Exchange proposed that such a carbon bank would only perform such functions as lending of permits, accrediting joint implementation projects and managing the national account. It would not act as a market regulator or have a compliance or governance role. Existing regulators would instead fill this role.

The Green Paper proposed that scheme caps and gateways be set by the Minister by way of delegated legislation. A number of stakeholders raised concerns about this approach and suggested alternatives including:

•        Indicators of scheme caps and gateways should be included in the establishing Act; actual scheme caps and gateways should be set out in delegated legislation (BP)

•        Matters the Minister would be required to consider in making determinations should be included in the legislation (Business Council of Australia)

•        The rules for determining the scheme caps and gateways could be set out in delegated legislation, but the scheme caps and gateways could be administered and announced by the scheme regulator, based upon national targets and trajectories determined by the Government (Energy Supply Association and others)

•        The Act and ministerial powers should be favoured over disallowable instruments, noting that the regulations prescribing scheme caps and gateways could be disallowed in the Parliament, creating uncertainty (CSR) 

The Australian Chamber of Commerce and Industry and Origin referred to Commonwealth-State governance arrangements, including the National Electricity Market, an arrangement involving a rule-making body, a separate body enforcing the regulation and the Ministerial Council on Energy. 

Origin expressed the view that it is not appropriate for the Government to devolve such decision-making powers to a fully independent body in the short term, but suggested as a compromise the creation of another body without binding decision-making powers but with a remit to provide recommendations to the Minister on matters such as the scheme cap, gateways, coverage and annual review. After the five year review, Origin suggested that the Government should consider devolving decision-making to the independent body.

Analysis of stakeholder comments

In assigning responsibility for roles to different parties, the basic principle followed is that the Parliament and Government should be responsible for the policy decisions with the most significant and far reaching implications. Governance arrangements are designed to provide as much certainty and predictability for regulated entities and the market as is practicable, while retaining a legitimate degree of flexibility for the Government to adjust the scheme in response to changed circumstances. It is appropriate that the Government, rather than regulator, is responsible for the key decisions, as it is ultimately responsible for the performance and implications of the scheme.

In keeping with this approach, decisions of a general nature that are crucial to the scheme and are unlikely to change will be made by the Parliament.  These include recognition of the medium- and long-term national targets and determining which sectors should be covered. To create greater certainty about how these decisions will be made, a reference to the medium- and long-term national target ranges will be included in the objects clause of the Act establishing the scheme and the factors that the Government may consider when making decisions on national targets and trajectories will be set out in the explanatory material.

The major cause of stakeholder concern is that the scheme caps could, if set in regulations, be disallowed by the Parliament, resulting in uncertainty around the central price determinant of the scheme. However, setting scheme caps is akin to setting a tax rate. While there is a risk that delegated legislation may be disallowed, the alternative would be to remove these key decisions from parliamentary oversight. Failure to include the scheme caps in the legislative framework would mean there would be no legally binding constraints on the number of permits that could be auctioned, creating even greater uncertainty. For these reasons, it is appropriate that decisions on scheme caps, scheme gateways and methods for measuring emissions be made by the responsible Minister with parliamentary oversight and be set out in delegated legislation. To address concerns that scheme caps may be disallowed in parliament, a default mechanism for setting scheme caps will be included in legislation.

As identified in stakeholder submissions, the Government recognises the need for a high level of transparency in decision-making, public participation and the involvement of experts to ensure the integrity of the scheme. The Government considers that these objectives can be achieved through the establishment a scheme regulator with a high degree of independence. The role of the regulator will be set down in legislation and the regulator will be given a high level of operational independence to implement the emissions trading scheme and apply it to individual cases. The Regulator will be accountable to the responsible minister and subject to ministerial directions of a general nature only. Also, an independent expert advisory committee, as proposed in the Green Paper, will be established to assist in the realisation of these objectives. 

Table 11.1 provides further details of the functions of the Parliament, the Minister, the Regulator and the independent expert advisory committee.

Table 11.1:  Proposed allocation of responsibility for key roles under the scheme

Decision/role

Responsibility

Form of the decision

Setting the medium- and long-term national emissions reduction targets

Parliament

An expert advisory committee may also report on this.

A reference to the 2020 target range and the 2050 target will be contained in the objects clause of the establishing Act.

Setting the scheme caps and gateways

The Government, through the responsible minister, with parliamentary oversight.

An expert advisory committee may make recommendations to the minister on caps and gateways from the first strategic review (scheduled in 2014).

The minister’s decision on the annual caps and gateways will be reflected in regulations.  The primary legislation will contain default scheme caps that will apply if regulations are not in place.

Determining which sectors should be covered initially and on what terms

Parliament

The sectors to be covered by the scheme will be set out in the establishing Act.

Determining which additional sectors should be covered as the scheme develops and on what terms

Parliament

An expert advisory committee may make recommendations to the minister on this.

The establishing Act will be amended to include additional sectors and possibly make specific provisions for them.

Determining the framework for assistance to emissions-intensive trade-exposed industries

Parliament and the Government, acting through the responsible minister.

An expert advisory committee may make recommendations to the minister on potential modifications to this framework from the first strategic review (scheduled in 2014).

Detailed provisions governing assistance will be set out in the establishing Act and regulations.

Determining strongly affected electricity generators and the quantum of free permits to be issued for each facility through the Electricity Sector Adjustment Scheme

Parliament and the Government, acting through the responsible minister.

 

Detailed provisions governing assistance will be set out in the establishing Act and regulations.

Deciding whether particular entities are eligible for assistance in the form of free permits, and the number of permits to be allocated

Regulator

The regulator’s decisions will be based on the establishing Act and regulations.

Deciding general principles for the banking and borrowing of permits

Parliament

An expert advisory committee may make recommendations to the minister on this.

General principles governing banking and borrowing will be set out in the establishing Act.

Applying banking and borrowing principles to individual cases

Regulator

The regulator’s role will be set out in the establishing Act.

Allocating carbon pollution permits, including handling auction proceedings

The minister will determine auction policy and operational rules from 1 January 2010 to 31 December 2011. The regulator will determine them from 1 January 2012. The minister’s determination will have effect until replaced or amended by the regulator.

An expert advisory committee may make recommendations to the minister on this.

The establishing Act will set out a broad framework for the conduct of auctions and assign a wide discretion to the minister/regulator to set auction policy and operational rules within that framework through legislative instruments.

Deciding which methods should be allowed for measuring and reporting emissions

The Government, through the responsible minister, with parliamentary oversight.

Set out in delegated legislation under the National Greenhouse and Energy Reporting Act 2007 .

Assessing emissions data to determine each liable entity’s obligation to surrender eligible compliance permits

Regulator

The regulator’s role will be set out in the establishing Act.

Monitoring, facilitating and enforcing compliance with the scheme

Regulator

The establishing Act will set out a broad compliance framework. A shortfall of units surrendered against emissions will trigger an administrative penalty and a ‘make good’ requirement. The regulator will also have a range of investigative, compliance and enforcement powers.

Operating a registry to track issues, holdings and transfers of eligible compliance permits

The regulator (with the capacity for services to be contracted out as appropriate).

The functions and the key features of the national registry will be set out in the establishing Act.

Detailed processes will be set out in the delegated legislation.

Deciding the nature and extent of linking between Australia’s Carbon Pollution Reduction Scheme and other schemes operating internationally

Parliament

An expert advisory committee may make recommendations to the minister on this.

The establishing Act will set out the international units that will be acceptable for surrender in the scheme.

 

Managing Australia’s assigned amount under the Kyoto Protocol and the Government’s registry account

The Government, through the responsible minister, will manage the purchase and sale of its own Kyoto units and (if required) carbon pollution permits.

The regulator will transfer units into and out of the Government’s registry account upon instruction, as it would for any other account holder.

The establishing Act will provide for the responsible minister (and other account holders) to instruct the regulator to make transfers of units.

Providing education on the scheme

The Government, through the responsible minister, and the regulator.

This role will be included in the establishing Act.

Reviewing the performance of the scheme and the effectiveness of the scheme settings

Parliament and the Government, through the responsible minister.

An expert advisory committee may make recommendations to the minister on this.

An outline of the five-yearly review process, including an indication of the timing, will be included in the establishing Act. It will specify the matters for review and the functions of the committee.

The regulator

This section covers the scheme regulator’s functions, accountability, structure and relationship with the Greenhouse and Energy Data Officer and the Renewable Energy Regulator.

The key functions of the scheme regulator will include the following:

•        Monitor, facilitate and enforce compliance with the scheme

•        Determine procedures for the auction of permits, and arrange auctions

•        Determine the eligibility of individual entities to receive free permits, and the quantity of permits to be allocated to them

•        Assess the emissions obligations of individual liable entities, based on emissions data reported under the National Greenhouse and Energy Reporting System

•        Assess any shortfalls in eligible compliance permits surrendered by liable entities

•        Maintain a national registry of eligible compliance permits (Kyoto units and Australian carbon pollution permits)

•        Open and close registry accounts upon request, and transfer eligible compliance permits, as instructed by account holders

•        Conduct education, information and outreach activities relating to the scheme

•        Provide information on the national registry and other matters, as required under Australia’s Kyoto Protocol obligations

•        Publish information related to the scheme (unless protected under the legislation)

•        Exchange information with specified agencies, bodies or statutory office holders to enable or assist them to perform their functions.

Nature of the regulator

As foreshadowed in the Green Paper, the Government has examined the advantages and disadvantages of amalgamating the functions of two existing regulators, the Greenhouse and Energy Data Officer and the Renewable Energy Regulator, with the proposed scheme regulator.  The Greenhouse and Energy Data Officer is responsible for administering the national greenhouse and energy reporting system and collects information on emissions levels for emissions trading and other purposes. The Renewable Energy Regulator is responsible for the administration of the Governments renewable energy target. The integration of these three regulatory functions under a single regulator would have a number of benefits:

•        improved regulatory outcomes, including reduced risk of conflicts or gaps emerging between regulators with separate functions

•        streamlining of procedures for reporting and surrender

•        reduced burden for businesses that would otherwise need to deal with two or three regulators

•        economies of scale in the administration of legislation

•        consistency with current Government policy on the Governance Arrangements for Australian Government Bodies.  

Stakeholders’ submissions have not raised concerns about this proposal. 

To ensure a smooth transition, consolidation of the three regulators will be implemented in a staged process with the following steps:

•        From December 2008, identification of systems and procedures that can be consolidated from formal amalgamation in September 2009

•        Amendment of the National Greenhouse and Energy Reporting Act 2007 and the Renewable Energy (Electricity) Act 2000 so that the one regulator performs the three functions

•        From September 2009, formal establishment of the combined regulator, with greenhouse and energy reporting, emissions trading and renewable energy target functions co-located and under a common internal governance framework

•        Progressive integration of systems and business processes.

The regulator will continue to perform existing functions under the National Greenhouse and Energy Reporting Act 2007 and functions under the expanded renewable energy target. Legislation will require this regulator to address these functions in its corporate plan and annual report.  In addition, the Government will ensure that members of the regulator have in combination qualifications and experience relevant to all of the regulator’s functions.

The regulator will be established as an incorporated body subject to the Financial Management and Accountability Act 1997 . It will have a commission structure with a minimum of three and a maximum of five statutory office-holders appointed by the responsible Minister.

The regulator will be required to report on its operations each financial year to the responsible Minister for presentation to the Parliament.  In addition, it will be required to have a corporate plan addressing specified matters. The regulator’s decisions will be subject to sound appeals processes, including judicial review pursuant to the Administrative Decisions (Judicial Review) Act 1977 and merits review by the Administrative Appeals Tribunal.

Funding

The establishment and ongoing operation of the scheme regulator will entail significant costs for Government.

These costs include employing staff to run the regulator, capital costs related to housing the regulator and information technology costs associated with the development and operation of an online auction platform, the establishment of an online permit registry to track ownership and maintenance of the online emissions reporting platform.

In the initial years of the scheme, funding for the regulator will be provided from the Commonwealth Budget. The desirability of cost recovery arrangements will be considered after the implementation of the scheme, taking into account the Government cost recovery guidelines.

Advisory committee and review of the scheme

The Green Paper suggested that there should be periodic, independent, public reviews of the scheme and that this would enhance the accountability and transparency of decisions made under the scheme. The process could also improve the environmental integrity and economic efficiency of the scheme by fostering consistency and predictability in decision making. It suggested that the review advice would be made public and the Government would take the advice into consideration when making decisions about the scheme.

The Green Paper listed the issues that reviews might usefully consider. It suggested that an ad hoc committee, constituted every five years, would be appropriate for this purpose.

A number of submissions to the Green Paper referred to the review, making varied suggestions:

•        that there be more clarity about the review process

•        that the five-year review be extended to include assessing the effectiveness of household and employment assistance

•        that there be fewer reviews and more depth to those reviews that do occur

•        that the first review occur after two years and then again after another three years

•        that an independent body, which would have a number of other functions to ensure integrity of decision-making, carry out the five-year review, and take into account the total climate change agenda, rather than simply the scheme.

Clearly there is a need for review to ensure that the scheme meets its objectives, does not create any unintended consequences and is fine tuned to optimise it performance. However, at this stage it is difficult to determine what will prove to be the most desirable timing — this will depend on the success of the scheme’s implementation and ‘bedding down’ period. That said, holding a review too early may give undue weight to transitional issues, in particular the operation of the scheme in the context of less developed secondary and other financial markets than we expect to develop over the longer term. Therefore, the preferred position is to hold reviews every five years, or earlier if the Minister makes a written determination specifying an earlier date.

The first review will be completed by 30 June 2014, and the independent expert advisory committee will be constituted with sufficient time before then for preparatory work. Adequate secretariat support will be provided to enable the committee to perform its functions effectively. Reviews will involve public consultation, and the advisory committee will be required to prepare a report of the review and give it to the minister. The Minister will be required to table the report in Parliament within 15 sitting days of receipt. If the report includes recommendations, the Minister will be required to prepare a statement of the Government’s response and table it within six months of receiving the report.

The establishing Act will provide that each subsequent review will be completed within five years after the last day on which the Government’s response to the previous review was tabled in parliament, or earlier if the responsible Minister makes a written determination specifying an earlier date.

The reviews will be undertaken by an independent expert advisory committee appointed by the Minister and will consider and make recommendations on the following:

•        the effectiveness and efficiency of the scheme as a whole

•        changes or extensions to the national targets

•        extensions to the scheme caps and gateways

•        whether additional sectors should be covered by the scheme

•        assistance policies relating to households and emissions-intensive trade-exposed industries

•        the appropriateness of ongoing emissions intensive trade exposed assistance for particular activities

•        auction design

•        the effect of and potential for international linking

•        borrowing limits

•        scheme governance arrangements, including the responsibilities of the regulator and the responsible minister’s power of direction

•        any other aspect of the scheme and its operation, which the responsible minister may request to be reviewed.

More frequent ‘care and maintenance’ reviews may be necessary in the early years of the scheme to assess the operation of administrative arrangements. To improve market certainty, the scope of those early reviews will be tightly defined. The conduct of such reviews is a common administrative practice and requires no legislative provisions.

Decisions, required either as a result of scheme reviews or for other reasons, will be informed by appropriate regulation impact analysis, in conformance with the Government Best Practice Regulation requirements. 

[As a regulation impact statement could not be prepared prior to the decision to introduce an emissions trading scheme, the Prime Minister granted exceptional circumstances relief from the best practice regulation requirements. For this reason, a post implementation review of this decision will be undertaken.]

Monitoring, facilitating and enforcing compliance

The Act establishing the scheme will set out a broad framework for monitoring, facilitating and enforcing compliance. The regulator will be given a range of compliance, investigative and enforcement powers, with the flexibility to select from a set of graduated options to respond proportionately to non-compliance. These powers will include information gathering powers, auditory functions, powers of inspection and the power to seek civil penalties or criminal sanctions for more serious breaches.  Additionally, an administrative penalty will apply automatically in the event of a unit shortfall (that is, where liable entities fail to surrender enough permits to cover their emissions).

Legislation

The scheme will be implemented through unitary Commonwealth legislation. States and Territories will be informally engaged as part of ongoing cooperation and coordination on climate change policy through the Council of Australian Governments.

Implementation

The intention is for the scheme to commence in the 2010 calendar year. It is important to ensure that business is ready to implement the scheme at this time. For this reason extensive consultation with business and other stakeholders will continue as the administrative systems of the scheme are developed. Using 1 July 2010 as an indicative start date for planning purposes, key implementation steps up to 2015 are outlined in table 13.2.

Key elements of the scheme are already in place with the commencement of the National Greenhouse and Energy Reporting Act 2007 on 1 July 2008. This Act provides key infrastructure for reporting emissions and will assist industry to put in place emissions reporting and build capacity prior to the commencement of obligations under the scheme.

To ensure smooth implementation of the scheme, work has already commenced to build additional infrastructure and capacity required to deliver the scheme. Early implementation tasks will be undertaken in a way that does not prejudice final decisions on scheme design. These tasks include:

•        the acquisition of a national registry (commenced in September 2008) and other essential IT systems

•        establishing the regulator

•        education and outreach to enhance liable and other entities’ understanding of the scheme and its requirements prior to the commencement of the scheme

•        preparing and trialling a system for auctioning permits.

The Government will create an interim regulator in early 2009 to ensure that key personnel are in place and administrative systems are well advanced before the regulator is formally established later in 2009. The interim regulator will have no statutory powers, but will be responsible for putting in place key systems and personnel to ensure a smooth start to the scheme.

The Government will consult on key implementation issues that affect stakeholders, such as the development of the registry, compliance procedures and strategy, and education and information activities.

The Minister for Climate Change and Water will have primary responsibility for scheme implementation.

Table 13.2:  Timetable for introduction of the emissions trading scheme

Year/

quarter

Date

Milestone

2008

 

 

4th quarter

December

Public release of the White Paper

2009

 

 

1st quarter

January

National registry operational with Kyoto Protocol functions and connected to International Transaction Log

Late February

Public release of exposure draft legislation

2nd quarter

 

Early April

Close of consultation period on exposure draft legislation

May

Bills to enact scheme (including consequential amendments) introduced into Parliament

June

Public release of key draft regulations

Government aims to achieve passage of the Bill through Parliament

3rd quarter

 

Central provisions of the Act establishing Carbon Pollution Reduction Scheme in force 28 days after Royal Assent

Regulator formally established

4th quarter

 

Stage I regulations and legislative instruments made and tabled in parliament following passage of Bill

2010

 

 

1st quarter

 

National registry operational with Carbon Pollution Reduction Scheme functions

Government announces:

—     extension of national emissions trajectory up to 2014-15

—     scheme caps for first five years of scheme (2010-11 to 2014-15)

—     10 years of scheme gateways after 2014-15

—     approach for expanding cap to accommodate increases in coverage

Stage II regulations and legislative instruments made and tabled in parliament

1st to 2nd quarter

 

First auction of permits

3rd quarter

1 July

Start of first compliance year under the scheme

2011

 

 

2nd quarter

30 June

End of first compliance year under the scheme

4th quarter

 

Trial reporting of agricultural emissions on a voluntary basis, through the National Greenhouse and Energy Reporting System

 

31 October

Deadline for liable entities to submit emissions reports through the National Greenhouse and Energy Reporting System

 

15 December

Deadline for surrender of eligible compliance permits for first compliance year

2012

 

 

4th quarter

31 December

End of first commitment period under the Kyoto Protocol

2013

 

Government announces final decisions on coverage of agriculture

A decision to allow for the sale and transfer of Australian carbon pollution permits internationally will not be made before 2013

2014

 

 

2nd quarter

June

Completion of the first public strategic review of the scheme by an independent expert advisory committee

4th quarter

December

Response by the Government to the report on the strategic review tabled in parliament (within six months of the report being delivered to the minister)

2015

 

Possible inclusion of agriculture in the scheme



Attachment A: Small Business Impact Statement

Small businesses are defined by the Australian Bureau of Statistics as any business with less than 20 employees.

Direct impacts

The direct impacts on small business from the emissions trading scheme are likely to be limited. Direct impacts refer to the obligation to acquire and surrender permits to cover emissions. In most areas the threshold for inclusion in the scheme is 25 kt CO 2 -e/year. This is a large level of emissions and it is doubtful whether any emitter who exceeds this threshold would be a small business (certainly they would have significant turnover [90] ).

One area where small businesses are likely to be directly covered is in regard to transport emissions. Transport emissions are covered by placing the liability for emissions on upstream suppliers (that is fuel importers, producers and distributors). The excise system is used as a mechanism to administer scheme responsibilities — those who pay excise on fuel are also liable to surrender carbon pollution permits for emissions associated with the fuel sold. As there is no threshold on the excise liabilities (small and large businesses alike are liable to pay excise), there will be small fuel importers or producers who are required to pay excise and who will also be required to surrender permits under the scheme.

The impact of the scheme on small fuel importers and producers is expected to be low. They already have to record fuel sales for the purposes of paying excise. All that is required under the scheme is that they multiply this volume of fuel sold by a default emissions factor to derive an emissions liability and then surrender sufficient permits to cover these emissions. It is expected that entities liable for a small volume of emissions will purchase permits from a financial intermediary (such as a bank). Furthermore, it is expected that any costs associated with the purchase of permits will be passed on to customers by way of increased fuel prices (limiting the financial impact on small business).

It is not known precisely how many small businesses will be impacted in this way. In total there are around 250 fuel excise remitters a portion of which are large businesses.

Another area where small businesses may incur obligations under the scheme is in relation to the coverage of forestry. There is no threshold limits governing the participation of forestry operators in the scheme. However, forestry participation is on an ‘opt in’ basis. As a result, small businesses would only incur costs from the emissions trading scheme if they chose to participate in the scheme. Moreover, forestry businesses would benefit from participation in the scheme (they receive permits for greenhouse gases stored in the forest) and would only opt in if the benefits of participation outweighed any costs.

One sector that has a significant number of small businesses with sizable greenhouse gas emissions is agriculture. At present, it is not proposed to cover emissions from agriculture in the scheme. This will limit the impact on small agricultural businesses (they will still incur indirect impacts as described below). If agriculture is subsequently included in the scheme there will be additional impacts, but these will be considered in the context of a decision to include agriculture.

Indirect impacts

The more important impacts on small business will be the indirect impacts associated with increases in the price of inputs. The emissions trading scheme will effectively put a price on greenhouse gas emissions (referred to below as carbon emissions). Products that ‘embody’ carbon emissions (that is, products where emissions were released in their manufacture) will rise in price. The degree of price rise will depend on the price of permits and the amount of carbon released.

The price of permits will depend on the cap set by Government, the design of the scheme and the cost of abatement in the economy. In putting forward preferred positions to Government the scheme has been designed to minimise the costs associated with meeting any given emissions target. The coverage of the scheme is recommended to be as broad as possible, subject to measurement and compliance cost constraints. The broad nature of the scheme should open up more avenues for carbon abatement, thereby ensuring that the lowest cost opportunities are pursued first. In allowing the use of certain international units to meet liabilities under the CPRS, the scheme will open up international abatement opportunities which will further reduce the costs associated with the scheme.

Nevertheless, the price of certain goods and services (those with a significant amount of embodied carbon) will rise. Significant price rises will be associated with electricity. Most electricity generation in Australia is derived from the combustion of fossil fuels which releases significant amounts of greenhouse gases. It is estimated that the price of electricity will rise by around 20 to 22 percent over the first five years of the scheme. [91] Electricity prices will continue to rise at a greater rate as a result of the CPRS. By 2050 prices are expected to be between 34 and 46 percent above the reference case (that is, the price that would have existed in the absence of the policy action to address climate change).

The prices of other goods are also likely to increase. In general, produces such as metals, cement and basic chemicals which have a high degree of embodied carbon will see the highest price rises. Prima facie, small businesses that use these products are most likely to be adversely affected by the scheme, although it is expected that most will be able to pass these costs on to their customers. [92]

The impact of the emissions trading scheme on fuel prices could have an impact on certain small businesses (such as transport companies and broad acre cropping enterprises). That said, fuel prices fluctuate as a result of changes in the exchange rate and international oil prices. The Garnaut review estimated that petrol prices would rise by 5 cents per litre in response to a permit price of $20. Permit prices are expected to be between $23 and $30 at the beginning of the scheme implying price increases of between 6 and 7.5 cents per litre. [93] These price rises are relatively minor in relation to other fuel price fluctuations.

In any case, the Government has committed to offsetting the impacts of the CPRS on fuel prices for households, on-road business users and agricultural and fishing industries for the first three years of the scheme. Heavy vehicle road users will have the initial impact of the scheme offset for the first year. This will occur through a cent for cent reduction in excise which will offset the increase in fuel prices associated with the introduction of the scheme. As a result, impacts on small business of petrol price increases will be limited in the initial years of the scheme.

Overall impacts

Overall the majority of impacts on small business will result from changes in the price of inputs. For some small businesses, which rely on emissions intensive inputs, these may be significant. However, it is expected that small businesses will be able pass on the majority of these increased costs to customers.

Moreover, the impacts on small business will be in proportion to the impacts on other businesses and households. Price rises faced by small businesses are likely to be inline with price rises felt by other sectors of the economy. Relative to larger businesses who have to participate directly in the scheme, the impacts on small businesses will be lower.

 



Attachment B: Compliance cost assessment

 

 

 

 

 

Input to Regulatory Impact Analysis

on Administrative Costs of the

Carbon Pollution Reduction Scheme

Final Report

Department of Climate Change

November 2008





 

Mr Russ Campbell

Assistant Secretary

Permit Allocation Branch

Department of Climate Change

GPO Box 854

Canberra ACT 2601

 

Private and Confidential

Dear Mr Campbell

Input to Regulatory Impact Analysis on Administrative Costs of the Carbon Pollution Reduction Scheme

Ernst & Young has completed its procedures, as outlined in our engagement letter dated 23 September 2008 and detailed in our Work Plan agreed on 10 October 2008 and present this report to the Department of Climate Change outlining our findings relating to additional administrative compliance costs associated with the implementation of the Carbon Pollution Reduction Scheme (CPRS).

We would like to thank you for the opportunity to work with you on this engagement.  Please do not hesitate to contact me on (07) 3011 3284 or 0417 619 388 or Mathew Nelson on (03) 9288 8121 if you have any questions regarding this report.

 

Yours sincerely

Lorraine Stephenson

Partner





Executive Summary

Background

The Carbon Pollution Reduction Scheme (CPRS) Green Paper was released by the Department of Climate Change (DCC) in July 2008, outlining the Australian Government’s preferred approach to a national emissions trading scheme.  Specifically, the paper outlines a range of design issues, for example, which industry sectors will be covered and how emission caps will be set. It also identifies approaches to support a robust carbon market, Emissions-Intensive Trade-Exposed (‘EITE’) industries and other strongly affected industries (‘SAI’), and possible reporting and compliance arrangements.

The Regulatory Impact Statement is developed by Government to ensure that the costs and benefits of, and alternatives to, all new or amending regulations that impose an appreciable burden on any sector of the community, are examined and public comments are sought.  DCC is therefore undertaking a Regulatory Impact Statement to analyse all the costs and benefits associated with the CPRS.  As part of developing the RIS, DCC has identified a need to assess the specific administrative costs facing industry from the CPRS over and above those requirements placed on them by the National Greenhouse and Energy Reporting System (NGERS).  

Findings

In order to identify and estimate the costs associated with our analysis, eight hypothetical companies were developed to represent a cross section of Australian industries likely to have a CPRS liability.  A summary of the findings related to these hypothetical companies identified as a result of our analysis are presented below:

Reporting and Compliance — For most of the hypothetical companies the administrative costs associated with reporting and compliance are expected to be the most significant ongoing cost.   This cost is reflective of the assurance costs required for companies emitting greater than 125,000 tonnes CO 2 -e or the monitoring and collation of data for companies without an existing NGERS liability or an additional liability under CPRS.  Our analysis also indicated that although it is expected that most of the hypothetical companies will require assurance, this requirement will only apply to a minority of liable entities under the CPRS.

Significantly impacted sectors — Our analysis identified that the company category with the highest administrative costs was the large industrial companies followed by petroleum refiners and electricity generators.  Due to the additional administrative processes required for waste and synthetic gas importers and an assumption that in general these company categories include companies with comparatively lower turnover, compliance costs on an earning basis are expected to be higher.

Timing of costs Start-up costs are expected to be greater than ongoing costs for all of the company categories.  Companies that are likely to receive EITE or SAI assistance (e.g. industrial processes and power generators) will also incur additional start-up costs in responding to these policy measures, although applying for this assistance will be voluntary. Our analysis indicated that the most significant start-up costs incurred by companies are those associated with the preparation for tax and accounting treatments including financial systems upgrades.  

Contract review — From our analysis we identified that for some of the company categories, a key cost of implementing the CPRS is expected to be reviewing and, where necessary, updating or renegotiating supply side and demand side contracts.  These costs were particularly significant for the company categories expected to have large purchase contracts (e.g. electricity contracts for industrial use), or companies with a large customer base which are seeking to pass on the cost of permits.  However, from our interview with a sample of actual companies, we identified that individual companies will potentially have different exposures to this issue and therefore the variation in potential costs are significant with estimates ranging from $38,000 to over $1million.  It was therefore difficult to extrapolate a standard cost for each of the hypothetical companies and as a result, these costs have not been included in the aggregated figures for CPRS costs.  Based on our discussions it was also difficult to establish which contract revision costs would be required to reflect compliance and which were related to driving more advantageous business outcomes.

Scope and Limitations

Scope and Approach

Ernst & Young was engaged by the DCC to provide findings in relation to the additional compliance costs associated with the CPRS over and above the requirements for NGERS.  

In order to determine the compliance costs, the following procedures were undertaken:  

•        Established a set of criteria for determining which additional costs related to the CPRS will be included in the analysis.

•        Determined a set of ‘typical’ (hypothetical) companies in which to identify costs which would be incurred as a result of the CPRS.  The typical companies were established to include:

-       Businesses with large (>125,000 t CO 2 -e)  and small (<50,000 t CO 2 -e) greenhouse gas emission profiles

-       Businesses with both mature and immature greenhouse gas emissions reporting processes

-       EITE and SAI businesses

-       Businesses with upstream liability such as fuel suppliers and synthetic gas importers

-       A range of emission sources (e.g. stationary energy, transport, industrial processes, fugitive emissions and waste)

-       Businesses with a liability under the CPRS but no obligation under NGERS (e.g. second tier gas retailers)

-       Determined what specific costs will be borne by these hypothetical companies

-       Estimated the quantum of the identified costs, calibrated through interviews with a selection of actual companies.

Further details of our approach and procedures undertaken can be found in Appendix A.

Limitations

The management of the DCC shall be fully and solely responsible for applying independent business judgement with respect to the advice and work product provided by us, to make independent decisions, if any, and to determine further courses of action with respect to any matters addressed.  This report should not be provided to any third parties without our prior approval. 

We disclaim all liability to any other party for all costs, loss, damage and liability that the other party may suffer or incur arising from or relating to or in any way connected with the contents of our report, the provision of our report to the other party or the reliance upon our report by the other party.

The nature and content of any advice provided necessarily reflects the specific scope and limitations of our engagement, the amount and accuracy of information available to us and the timescale within which the advice is required. These services are advisory in nature and thus do no constitute an audit or review in accordance with Australian Auditing Standards or an engagement to perform agreed-upon-procedures.

The following limitations and qualifications should also be noted:

The draft legislation surrounding the CPRS has not yet been released.  Whilst the Green Paper provides guidance on the likely administrative activities, some areas of legislation require further development such as the likely enforcement provisions, minimum methodologies to be applied, requirements for strongly affected industries, accounting and taxation treatments etc.  As such, the administrative compliance cost estimates are based on a variety of assumptions on the likely design outcomes for the scheme.

While cost estimates were validated with a small sample of companies aligned to the associated hypothetical company, there is limited quantitative information and evidence in key areas (e.g. additional costs for correct taxation treatment and costs associated with carbon markets and auctioning) and therefore estimates for costs have a high degree of uncertainty.

Our analysis focussed on establishing the potential compliance costs of an assumed base case approach to ensuring compliance with the CPRS. 

Assumptions and Criteria

Assumptions

As set out in our scope above, the first step in developing the model to assess the administrative costs associated with the compliance requirements for the CPRS is to establish a set of criteria and assumptions to guide the model.  In undertaking our analysis, the following key assumptions were made:

Substantive compliance costs, including the direct costs of purchasing carbon permits, pass through costs from suppliers, costs associated with raising funds for the purchase of permits and costs associated with implementing internal abatement projects are excluded (we understand that these costs will be identified and assessed as part of the general equilibrium modelling undertaken by the Treasury).

Compliance costs are assessed as either:

•        start-up ’ costs: costs associated with activities undertaken prior or immediately subsequent to CPRS commencement

•        ongoing ’ costs: costs associated with activities required to be undertaken on an annual basis in the early years of preparation and scheme commencement

In lieu of draft CPRS legislation, compliance requirements are determined based on the preferred positions documented in the Government’s Green Paper, July 2008.

Where the Green Paper preferred positions are not definitive, the following assumptions have been made:

•        liability is determined on an operational control as defined in NGERS

•        there will be compliance activities associated with obtaining assistance in the form of cash payments and free permits; however the assistance once provided is not tied to additional reporting or performance requirements (except for annual production reporting for free permits).

Companies will be assessed from a base-case scenario consisting of a minimum level of scheme participation and full compliance (i.e. no international trading, no brokering, limited management of increased debt, limited periodic permit purchase and acquittal, no enforcement of compliance required) 5 [94] .

Contract revision costs have been excluded from the base case compliance assessment due to the large variability in these costs to an individual company (e.g. dependant on the nature of the business and the completeness of existing contracts) and the potential contribution of the contract revision to drive better business outcomes rather than just to achieve minimum compliance (e.g. where supply contracts are revised and negotiated to reduce the impacts of cost pass through). 6 [95]

As agreed with DCC, the cost model and cost criteria are based on the Victorian Competition and Efficiency Commission’s (VCEC) Victorian Guide to Regulation.

Cost Criteria

For the purposes of our analysis, the cost model and cost criteria used are based on the VCEC’s Victorian Guide to Regulation .  Under the VCEC Guide, compliance costs can be defined as:

Substantive compliance costs - those costs that directly lead to the regulated outcomes being sought such as capital outlays and production costs. These costs are often associated with content-specific regulation and include, for example, the cost of purchasing carbon pollution permits.

Administrative costs - administrative costs are those costs incurred by business to demonstrate compliance with the regulation or to allow government to administer the regulation. Administrative costs can include those costs associated with familiarisation with administrative requirements, record keeping and reporting, inspection and enforcement of regulation. 

As agreed with DCC, our analysis is focused on the administrative costs of compliance with the CPRS rather than substantive costs which we understand are examined in other ways including through general equilibrium modelling undertaken by the Treasury.

Cost Categories

For the purposes of our analysis, the administrative costs have been broken down into five cost categories as outlined below.  These categories have been amended from those provided by the Office of Best Practice Regulation (OBPR) guidelines which are recommended for use by government entities who propose to introduce various regulatory instruments and are required to indentify and quantify the associated business compliance costs.

Cost Category

Description

Education/Capacity Building:

Costs incurred by a business in keeping abreast of regulatory requirements

Enforcement:

Costs incurred by a business when cooperating with audits or inspections

Monitoring/ Record Keeping:

Costs incurred by a business in keeping records up to date

Reporting/Notification:

Costs incurred by a business in meeting the reporting requirements of the CPRS

Assurance (sub-set of Reporting/Notification):

Costs incurred by a business in gaining assurance of its greenhouse gas emissions

Other:

Other costs incurred by a business in meeting CPRS regulatory requirements.  This may include legal, tax and accounting costs and transaction costs associated with purchase and acquittal of permits.

As noted in the assumptions, compliance costs are assessed as either ‘start-up’ costs for once off activities undertaken prior to CPRS commencement or ’ongoing’ costs for activities required to be undertaken in the early years of preparation and scheme commencement. The ongoing cost time frame defined in the early years of preparation and scheme commencement reflects that these costs are likely to be more significant in the initial period the scheme and have the potential to fall over the longer term as they are incorporated into standard business practices.

In addition to analysing costs by the cost category as outlined above, the administrative cost assessment was undertaken of key processes required to be undertaken to achieve legislative compliance.  The Government’s preferred positions as outlined in the Green Paper were used to categorise the following five key processes:

Process/Requirement

Description

1. Carbon Markets and Auctioning Permits

The process of purchasing, banking, selling, brokering and surrendering permits in accordance with the established auction system.

Refer: Chapters 3 and 7 of the Green Paper

2. Reporting and Compliance

The process of monitoring, reporting and assuring greenhouse gas emissions in accordance with Scheme requirements.

Refer: Chapter 5 of the Green Paper

3. Tax and Accounting Issues

The process of updating accounting and tax systems and processes in order to correctly account and pay tax on greenhouse gas emissions and emission permits.

Refer: Chapter 11 of the Green Paper

4. Emissions Intensive Trade Exposed Industries (EITE)

The additional processes associated with companies which fall under the EITE industries including the submission of additional information and meeting additional compliance requirements to receive assistance and the ongoing reporting and accounting processes.

Refer: Chapter 9 of the Green Paper

5. Strongly Affected Industries (SAI)

The additional processes associated with companies which fall under the strongly affected industries including the submission of additional information and meeting additional compliance requirements to receive assistance.

Note: the application process for the SAI sector is likely to be substantially different to the EITE application process.

Refer: Chapter 10 of the Green Paper

Hypothetical Companies

In order to identify and estimate the costs associated with the analysis, eight hypothetical companies were developed to represent a cross section of Australian industries likely to have a CPRS liability.  The companies were selected to ensure coverage of key emission sources including stationary energy, fugitive, industrial processes, waste and transport and an attempt to cover other key differentiators including the quantity of emissions, maturity of reporting and additional CPRS requirements for companies classed as EITE, SAI or companies with upstream liability under the CPRS (Note that applying for assistance under EITE or SAI or responding to Government requests for related information is voluntary).

Refer to section 5.3 in Appendix A for further details on the selection and description of hypothetical companies.

Analysis

From our discussions with a sample of impacted companies and our own analysis, the start-up and ongoing costs required to comply with the CPRS are expected to be relatively small in comparison with:

•        complying with the requirements of NGERS 7 [96]

•        the substantive costs associated with the purchase of credits or

•        the commercial costs associated with seeking to optimise the business outcomes of trading.

Although the administrative costs are not expected to be comparatively significant, our analysis identified that the ongoing and start-up administrative costs of compliance in some cost categories were identified as material. 

Outlined below are details of our specific findings and outcomes of our analysis related to these identified costs.

Cost by Key Process

Carbon Markets and Permits

The introduction of the CPRS will require companies to consider a range of commercial arrangements in order to ensure they are compliant with the CPRS and other legislative frameworks.   Start-up and ongoing costs associated with Carbon Markets and Auctioning Permits are both expected to be significant.  The most significant contributor to this start-up cost identified across all companies was the cost associated with management’s review of organisational strategy and assessment of the business implications of the CPRS as well financial modelling of potential cost pass through. 

Our analysis also identified that costs associated with the modelling of cash flows for the purchase of permits is likely to be a material ongoing cost for most of the company categories and in particular for large emitters or companies with complicated supply chains.  Another potentially significant cost to companies is the cost associated with raising funds for the purchase of permits.  This cost is highly dependent on the number permits to be purchased and thus the quantity of liable emissions and also on the financial structure of the organisation.  As such the administrative costs of planning and modelling various funding options have been included in this assessment, but the actual financial costs of raising capital have be excluded.   

It is also worth noting that in some circumstances, companies will be seeking to pass on the substantive costs of the CPRS and may be collecting revenues in advance of the need to purchase permits.

Another additional and potentially significant cost identified beyond the base case assessment, was associated with the process of revising and negotiating both purchase and sale contracts throughout the supply chain and notifying customers of contractual changes.  For example, contract revisions likely to incur costs include:

•        Purchase contracts - costs associated with the revision of purchase contracts for items such as gas, electricity and steam. 

•        Sale contracts - costs associated with redrafting sales contracts for companies with a large customer base.

Whilst contract revision costs are likely to impact all hypothetical companies, some sectors and companies are likely to be impacted more considerably than other. Companies in the gas retail sector may be more significantly impacted due the large customer numbers for review and notification and potential contract variability between sets of customers, with costs of over $1 million expected for some companies.  Some large industrial processors are also likely to be more significantly impacted from the revision of large long term supply contracts.

As noted in the assumptions, contract revision costs, whilst significant, have been excluded from the base case compliance assessment due to the large variability in these cost to an individual company and the difficulty in establishing which contract revision costs would be required to reflect compliance and which were related to driving more advantageous business outcomes.

Figure 1: Cost by Key Process (average cost across relevant hypothetical companies)

Reporting and compliance

Our analysis indicated that on average the cost category related to Reporting and Compliance had the most significant ongoing costs for all hypothetical companies (see Figure 1).  Whilst many of the CPRS greenhouse gas emissions reporting requirements are underpinned by NGERS and have previously been considered as part of the analysis of the NGERS RIS, we have identified additional reporting and compliance requirements under the proposed CPRS design. Specifically, additional reporting and compliance costs for the CPRS identified from our analysis across company categories include:

•        Assurance - for entities emitting over 125,000 tonnes CO 2 -e, assurance will be required which will incur both external and internal costs.  Additional assurance requirements for entities emitting less than 125,000 tonnes CO 2 -e may also be required where emissions or permits are material for financial statements. Note, some large companies may already be obtaining assurance over greenhouse gas emissions (voluntarily or through programs such as Greenhouse Challenge Plus), so for these companies the additional assurance compliance cost are substantially reduced.

•        Frequency of greenhouse gas emissions data capture - it is expected that companies will need to capture emissions data more frequently than is required under NGERS, as data will be required for management accounting purposes (e.g. forecasting of financial costs) and preparing for permit auctions.

Companies with additional or new reporting liability under CPRS (compared with NGERS reporting obligations) may also face additional costs related to education of personnel, monitoring and reviewing of reporting legislation and development of data capture processes, including transfer of sales related data and netting out and measuring and collating additional liable emissions data (e.g. customer gas use, imports of synthetic gas). 

Tax and Accounting

Our analysis indicated that on average the cost category related to Tax and Accounting issues had the most significant start-up costs for all hypothetical companies (see Figure 1 above), with the largest contributor from the systems capacity upgrade to link operational and financial data.  Tax and accounting compliance is also expected to result in some ongoing costs for company categories including activities associated with accounting for the liability and the permits in annual reporting and business activity statements.  From our discussion with companies, we note that the general understanding of tax and accounting issues related to the CPRS is limited with details of the requirements under the CPRS design still to be established.  It is important to note that cost estimates under this category are difficult to estimate due to the uncertainty in the legislation and the companies’ progress in dealing with tax and accounting elements.  The selection of either of the two valuation methods presented in the Green Paper: historical and market value , is also likely to have an impact on the costs incurred related to tax compliance.  Our estimates have assumed that the CPRS will be implemented using the simpler of the two valuation methods for tax treatment.

Emissions Intensive Trade Exposed/ Strongly Affected Industries

Companies with the potential to be classified as EITE or SAI may be required to execute on a number of specific additional activities and therefore face increased compliance costs in order to gain assistance in the form of upfront cash grants or annually allocated free permits.  These costs result mainly from the anticipated development of an application for assistance and the application of correct tax and accounting treatments for the assistance provided.  In addition, assurance of historical data is a significant once off cost that may be required for the EITE process along with additional compliance costs associated with companies potentially being required to provide information related to a ‘Gross Value Add’ metric. As noted in the section 3.1, we have assumed that once the assistance is provide there are no additional ongoing costs associated additional reporting or performance requirements tied to the free permit or cash grant.

Cost by Category

The greatest compliance costs faced by companies are start-up costs in the other cost category including legal, tax and accounting costs and transaction costs associated with purchase and acquittal of permits.  Other costs also include costs associated with applying for assistance under EITE or SAI. Most materially and consistently across companies within this cost category is the requirement to upgrade internal systems for reporting and monitoring purposes.

Figure 2: Cost by Category (average cost across all companies)

Reporting costs are low across most companies due to the alignment with NGERS reporting requirements. Of note, reporting costs are higher for companies without NGERS or with additional liability above NGERS.   Assurance costs as a subset of reporting are a more significant and ongoing cost especially for companies with emissions great than 125,000 tonnes CO 2 -e.

As noted in the description of cost categories (Section 3.3), many ongoing costs are likely to be more significant in the initial period of the scheme and have the potential to fall over the longer term as they are incorporated into standard business practices.  For example, in the longer term costs associated with standard business activities such as monitoring and reviewing legislation and pronouncements from tax and accounting bodies would be expected to fall.  Ongoing costs that are not likely to reduce in the longer term as those associated with new business requirements such as assurance of annual emissions.

Sector comparison

Our analysis identified that the greatest start-up compliance costs will be faced by industrial processors, followed by petroleum refiners and electricity generators.  Ongoing costs are likely to be consistently more significant across upstream oil and gas, electricity generators, industrial processors, petroleum refiners and gas retailers. 

Figure 3: Cost by Hypothetical Company (total cost)

It is important to note in the context of the company categories that our analysis does not provide consideration of compliance costs on an earnings basis, potentially impacting the perceived burden of companies in the waste and synthetic gas (without pre-existing liability) sectors.

Outlined below are details of our specific findings related to each hypothetical company:

•        Upstream Oil and Gas - Start-up costs are largely a result of the required systems capacity upgrade to link operational and financial data, as well as management review around the business implications of the CPRS. Oil and Gas companies also face costs associated with the additional requirement to collect and report data associated with its LPG/LNG liability. Ongoing costs are increased by the requirement to annually gain assurance over emissions.  It has been assumed that this hypothetical company is not eligible for EITE assistance.

•        Electricity generator - Electricity generators are also likely to face increased start-up costs as a result of activities surrounding systems capacity upgrade, management review around the business implications of the CPRS as well as the additional costs associated with obtaining SAI assistance. Ongoing costs are increased by the requirement to annually gain assurance over emissions.

•        Synthetic gas importer - Significant start-up costs are likely to be associated with the systems capacity upgrade and enhancing data collection and reporting systems due to absence of a pre existing NGERS requirements.  There is a potential cost overlap with the reporting requirements of the Ozone Protection and Synthetic Greenhouse Gas management Act 1989 .

•        Industrial processor - Industrial processor start-up compliance costs are likely to be larger across the board due to the size and complexity of the businesses in this sector. Although not included in the base case, some of these companies are likely to face significant contract revision costs for large supply contracts such as electricity.  Additional start-up costs are required to gain and manage EITE permits and upgrade systems capacity. Ongoing costs are increased by the requirement to annually gain assurance over emissions.

•        Petroleum refiner - Petroleum refiners’ start-up costs are increased by the activities associated with gaining, managing and accounting for EITE permits, including assurance over historical emissions and application development.  Other significant start-up costs for this sector include systems upgrade to capture the additional downstream liability and education and management review around the business implications of the CPRS. Ongoing costs are increased by the requirement to annually gain assurance over emissions.  Although not included in the base case assessment, petroleum refiners will also need to consider the costs associated with the revision of contracts.

•        Manufacturer - The smaller manufacturing company is likely to face the smallest ongoing compliance costs largely due to the absence of a requirement to obtain assurance over emissions data.  Significant start-up costs for the smaller manufacturer are likely to be associated with systems capacity upgrade to link operational and financial data and the additional costs associated with reviewing contracts both for customers and suppliers.

•        Gas retailer - Non-integrated or second tier retailers face start-up costs associated with enhancing data collection and reporting systems due to absence of a pre existing NGERS liability.  Ongoing costs are increased by the requirement to annually gain assurance over emissions. Although not considered in the data presented in this report, it is important to note that in some cases gas retailers potentially face large contract review and notification costs based on large customer numbers.  Companies with customers in the order of 300,000 to 500,000 may face associated costs in the range of $1-2 million.  Given that this cost is based largely on customer numbers and the ability of existing contracts to pass through the liability, some gas retailers may have substantially reduced compliance costs.

-       Gas retailers or other companies with a high volume of customers also potentially face additional costs from the education and management of customers as well as the increased debt portfolio they will carry as a result of the pass through of the costs of the CPRS onto customer invoices.  The costs associated with managing an increased debt portfolio are difficult to estimate due to differences in a company’s financial structure.   Whilst these costs have the potential to be significant for some sectors, they have not been estimated in this assessment of compliance costs.

•        Waste treatment - Significant start-up costs for the waste sector are likely to be as a result of activities associated with contract revisions, management review of the business implications and modelling the potential cost pass through to customers.

Uncertainty

It is important to consider the uncertainty surrounding the estimate of start-up and ongoing compliance costs in order to place the estimates in context and understand in more detail which estimates are more likely to change. An overall uncertainty has arisen from the limited knowledge of future regulatory requirements due to timing of this assessment being undertaken prior to the release of draft CPRS legislation.  To manage this and other uncertainties the cost assessment was undertaken within a range of assumptions to simplify and clarify boundaries and likely regulatory requirements. (See Section 3.1 for details of the assumptions). If assumptions were to change, there is the potential for significant changes to cost estimates.  In this respect, key assumptions include base-case scenario consisting of a minimum level of scheme participation and full compliance and the exclusion of substantive costs.  Many companies indicated significantly greater costs to the organisation from the CPRS (e.g. setting up a trading desk, assessing and implementing abatement opportunities, systems and data collation to meet high calculation levels etc.) but the costs associated with these activities were determined to be either substantive costs or cost incurred by activities assumed to be over and above the base case assessment.

By Sector

In discussions with companies the uncertainty around compliance cost estimates was found to be the greatest in the sector with responsibility for synthetic gas liabilities.  This is potentially due to this sector not having a reporting obligation under NGERS as well as the uncertainty surrounding the relevant preferred positions in the Green Paper such as the threshold and the state of preparedness of companies in this sector.  Some companies in this sector with a likely liability had not begun to consider the required compliance activities for the CPRS. 

Discussions in the waste to landfill sector identified inconsistencies within the sector as to the most appropriate measurement techniques for greenhouse gas emissions and the costs associated with implementing higher order methods.  This divergent view should be considered when determining if additional method requirements will be placed on the waste sector as identified in the Green Paper.  There was a level of inconsistency between companies in all sectors due predominantly to variances in the size and nature of the organisation being interviewed. 

By Key Process and Cost Category

Based on the conversations with companies we noted a greater level of uncertainty associated when estimating the cost of compliance activities such as the purchase of and surrender of permits as well as activities surrounding tax and accounting issues.  The uncertainty around tax and accounting activities could potentially be related both to the lack of certainty provided by the Green Paper and the stage at which most companies are at in preparing for the CPRS. To improve the certainty around the tax and accounting cost estimates, internal consultations were undertaken with Ernst & Young’s tax and accounting specialists.

Due to a more mature market and previous experiences, estimates for monitoring, record keeping, reporting and assurance cost categories were more certain than those in the other categories.



Detailed Findings

The following tables display the detailed findings of stat-up and ongoing costs for each cost category across all hypothetical companies.

Table 1 and 2: Start-up and Ongoing costs by cost category

Cost Category

Company A - oil and gas

Company B - electricity generator

Company C - synthetic gas importer

Company D - industrial processor

Start-up

Ongoing

Start-up

Ongoing

Start-up

Ongoing

Start-up

Ongoing

Education/Capacity Building

$35,767

$13,938

$39,739

$13,938

$18,068

$7,499

$65,969

$11,084

Monitoring/Record Keeping

-

$27,979

-

-

$10,000

$5,142

-

-

Reporting/Notification

-

$993

-

$993

-

$1,928

-

$676

Assurance

-

$152,979

-

$164,897

-

$2,571

-

$160,140

Other

$360,444

$82,430

$548,114

$94,348

$300,632

$50,131

$838,582

$99,373

Total ( Start-up and Ongoing )

$396,210

$278,320

$587,853

$274,176

$328,700

$67,271

$904,550

$271,274

 



Cost Category

Company E - petroleum refiner

Company F - manufacturer

Company G - gas retailer

Company H - waste treatment

Start-up

Ongoing

Start-up

Ongoing

Start-up

Ongoing

Start-up

Ongoing

Education/Capacity Building

$44,705

$13,938

$18,900

$11,084

$47,739

$13,938

$16,028

$10,050

Monitoring/Record Keeping

-

$11,918

-

-

$20,000

$23,835

-

-

Reporting/Notification

-

$2,979

-

$676

-

$10,924

-

$561

Assurance

-

$164,897

-

$2,704

-

$164,897

-

$2,244

Other

$618,970

$118,183

$262,857

$36,504

$305,478

$77,464

$337,033

$45,450

Total ( Start-up and Ongoing )

$663,675

$311,915

$281,757

$50,969

$373,217

$291,059

$353,061

$58,305

The following tables display the detailed findings of stat-up and ongoing costs for each key process across all hypothetical companies.

Table 3 and 4: Start-up and Ongoing costs by key process

<

Process

Company A - oil and gas

Company B - electricity generator

Company C - synthetic gas importer

Company D - industrial processor

Start-up

Ongoing

Start-up

Ongoing

Start-up

Ongoing

Start-up

Ongoing

1. Carbon Markets and Auctioning Permits

$119,739

$56,643

$221,519

$72,533

$71,140

$34,493

$271,401

$75,305

2. Reporting and Compliance

$11,918

$185,924

$8,938

$169,863

$15,784

$12,211

$6,084

$163,520

3. Tax and Accounting Issues

$264,554

$35,753

$264,554

$31,780

$241,776

$20,567

$393,941

$21,632

4. SAI

-

-

$92,842

-

-

-

-

-

5. EITE

-

-

-

-

-

-

$233,124

$10,816

Total ( Start-up and Ongoing )

$396,210

$278,320

$587,853

$274,176

$328,700

$67,271

$904,550

$271,274

Process

Company E - petroleum refiner

Company F - manufacturer

Company G - gas retailer

Company H - waste treatment