Client Alert September 2015 Deep dive: Climate change policy and the Australian market - the current state of play and key considerations for business Recent announcements by the Australian Government relating to its policy on climate change have revealed some important new information - and potential opportunities - for business, although uncertainty still surrounds some key elements of the overall policy framework. Despite the recent change in leadership of the Government, we do not expect resultant changes to these announced positions in the short term. On 11 August 2015, Australia announced its long awaited proposed emissions reduction target for the period beyond 2020 (known as its intended nationally determined contribution or INDC). Australia is proposing to reduce it greenhouse gas (GHG) emission to 26-28% below 2005 levels by 2030. The Australian government says its INDC offers a responsible contribution to a global problem, having regard to Australia's national circumstances, in particular our economic structure and population growth. The Government has, in particular, noted the significant contribution that resources and agriculture have to the Australian economy, along with our strong reliance on fossil fuels for energy. The Government has indicated that the INDC will be met primarily through its Direct Action policy, including the Emission Reduction Fund and the Safeguard Mechanism, along with improvements in energy productivity. On 2 September 2015, the Government released exposure drafts of the legislative rules that will underpin the Safeguard Mechanism. These are expected to be finalised in the coming months for the mechanism to commence on 1 July 2016. The Government has also released further guidance on the auction rules for the second ERF auction, which will be held on 4-5 November 2015. The announcement of Australia's INDC provides an indication of how Australia's climate change policy will develop in the coming months and years and raises a number of issues for businesses to consider. At the end of this alert, you will find our observations for business arising from the current state of play. Below, we explore in more detail some of the key issues for Australian and international companies that may be affected by Australia's emissions reduction target. 2 Deep Dive: Climate Change Policy and the Australian Market September 2015 1. What is an INDC and how does Australia compare to other countries? The Paris Climate Change Meeting The INDC is being put forward as Australia’s contribution to a new global climate change agreement which will be negotiated in December 2015 in Paris at the 21st conference of the parties to the United Nations Framework Convention on Climate Change (COP 21). Parties to the UNFCCC have been developing the framework for an agreement which will outline climate contributions for all countries for the period beyond 2020. The INDCs are a central component of that agreement. The form and content of an INDC is country-specific and undertakings may be expressed by reference to: • quantifiable information on the reference point (including, as appropriate, a base year), • time frames and/or periods for implementation, • scope and coverage, • planning processes, • assumptions and methodological approaches including those for estimating and accounting for anthropogenic greenhouse gas emissions and, as appropriate, removals, and • how the Party considers that its intended nationally determined contribution is fair and ambitious, in light of its national circumstances, and how it contributes towards achieving the objective of the Convention as set out in its Article 2. How does Australia’s INDC compare? To date, 31 developed and developing countries (including the European Union) have submitted their INDCs and more are expected to do so well in advance of COP 21. The approaches adopted to present INDCs is highly variable, reflecting each country's national circumstances. Among Australia’s major trading partners, INDCs include: EU – at least 40% below 1990 levels by 2030. This is the strongest target in terms of absolute emissions; however, as a result of the early adoption of renewable energy and low carbon solutions in many EU member states, the target is viewed a being achievable with only limited changes to business as usual. At present the EU does not intend to use international credits to meet its target. However, this may be used as leverage to take a more ambitious target during the political negotiations at the COP. 3 Deep Dive: Climate Change Policy and the Australian Market September 2015 USA – 26% - 28% below 2005 levels by 2025. The US target is quite strong in absolute emissions terms and moderately strong in terms of emissions intensity. What is interesting about the US approach is that it proposes that the target be met primarily through the adoption of regulatory standards , including the recently announced requirement that power plant owners must cut carbon dioxide emissions by 32 per cent from 2005 levels by 2030. The recent changes to the energy mix (from coal to gas) in the US is also viewed as an important contributor to the US being able to achieve this target. Canada – to reduce its emissions by 30% from 2005 levels by 2030. Commentators view this target a relatively weak in absolute terms, although it does represent a significant change in emissions intensity. We note that a number of Canadian provincial governments have adopted more ambitious climate goals and are engaging in activities to reduce emissions, including through the use of emissions trading schemes (Quebec, [Ontario]) and carbon taxes ([British Columbia]). Interestingly, Canada has indicated it is open to the use of market based mechanisms to meet its target, although it had previously pulled out of the Kyoto Protocol. Japan – to reduce its emissions by 26% below 2013 levels and to meet 42-46% of its energy generation with non-fossil based power by 2030. Whilst considered relatively weak, especially against earlier pledges made by Japan, this target takes into account the significant setback Japan suffered with the Fukushima nuclear disaster in 2011 and its increased reliance on coal-fire energy following that disaster. Japan’s INDC highlights that between 50 to 100 MtC02e per year will be reduced via the Japanese Crediting Mechanism. Japan has signed bilateral carbon offset agreements with 14 countries around the world to date. New Zealand - to reduce emissions by 30% below 2005 levels by 2030. New Zealand's target is viewed as being inadequate by commentators such as Climate Action Tracker. This is on the basis that, excluding the land use, land use change and forestry sectors, the target will allow for an increase in emissions across agriculture, energy, waste and industrial processes. China – to peak CO2 emissions by 2030 and make best efforts to peak early; to reduce emissions intensity per unit of GDP by 60-65% from 2005 levels by 2030. To increase forest stock by 4.5 billion cubic meters on 2005 levels. The Chinese INDC also notes that it intends to steadily implement its national carbon market (backed by robust measurement, reporting and verification (MRV) and accounting provisions), building upon the existing emissions trading scheme (ETS) pilots to ensure that the market ‘plays the decisive role in resource allocation’. South Korea – to reduce emissions by 37% below BAU in 2030. This target is considered quite ambitious, having regard to the current energy mix and efficiency in the Korean power sector. However. South Korea also intends to use international market mechanisms to meet its 2030 target. Of the other developing countries that had submitted their INDC at the time of writing, most have built their 2030 target against a business as usual 4 Deep Dive: Climate Change Policy and the Australian Market September 2015 scenario and most include both unconditional and conditional reduction commitments. Conditional targets are, in most instances, linked to being able to access bilateral, regional and international market mechanisms. For a full list of INDCs click here:(http://www.c2es.org/indc-comparison) The INDC proposed by Australia is at the low end of targets being put forward by comparable countries. Australia’s INDC is also significantly lower than the target proposed by the Climate Change Authority (CCA) in July 2015. The CCA recommended that Australia commit to: • a 2025 target of 30% below 2000 levels; and • further reductions by 2030 of between 40% and 60% below 200 levels. The CCA justified its proposed targets by reference to (i) what the scientific evidence is telling us is required to avoid dangerous climate change, (ii) what comparable countries are doing to address climate change and (iii) what it saw as being in the best interests of present and future generations. The CCA noted that adopting the more stringent targets proposed would be challenging, but no more so than the actions that other countries are taking. In addition, taking action now would have major benefits to Australia both in terms of avoiding dangerous climate change impacts and embracing opportunities associated with the transition to a low carbon economy. 2. How will Australia achieve its INDC? The Government plans to achieve its INDC through a range of policy measures which will build upon its current Direct Action Policy. Those detailed policy measures will be determined in 2017-2018. The current Direct Action Policy has two components - the Emission Reduction Fund (or ERF) and the Safeguard Mechanism. The ERF was originally announced as a $2.55 billion fund which buys abatement from projects developed under the Carbon Credits (Carbon Farming) Act 2011 (C'th) (CFI Act). Although the CFI Act was initially focussed on supporting emission reduction and carbon sequestration projects in the agriculture, waste and land sectors, the available methodologies have been expanded to support projects in the industrial, energy, transport and building sectors (see below). The ERF was initially budgeted to purchase abatement over the forward estimates to 2018. The Minister for the Environment has confirmed that a further $2.4 billion will be allocated for the period 2018 - 2030. This equates to approximately $200 million per year. The Safeguard Mechanism is intended to limit the growth in Australia's GHG emissions by applying an emissions baseline to Australia's largest emitting facilities and requiring companies that exceed their baseline to pay a penalty or offset their excess emissions. The regulations for the Safeguard Mechanism are still under development, with the mechanism due to commence in July 2016. The Government has indicated that Safeguard Mechanism is not intended to be punitive or raise revenue, and baselines are 5 Deep Dive: Climate Change Policy and the Australian Market September 2015 expected to be set conservatively. However, with the proposed 2030 target, greater effort is likely to be required, which could be achieved through applying more stringent baselines (see discussion below). The Australian INDC contemplates the introduction of a National Energy Productivity Plan with the goal of improving energy productivity by up to 40% by 2030. It is unclear what this might involve, however we assume that a key element will be supporting energy efficiency in commercial and industrial buildings. In addition, the government intends to improve the efficiency of vehicles, improve the utilisation of solar power, phase down hydrofluorocarbons and develop a low emissions technology roadmap. Many of these initiatives are already in train, for example through the renewable energy target and Australia's obligations under the Montreal Protocol. The Government has stated that it will consider the policies required to achieve its INDC in 2017/2018. This will give it two years to consult and develop those policies before it nominally needs to ratchet up its actions (assuming it does not increase its ambition for its 2020 target). At present, what is clear is that the policy response under the current Liberal Government would not involve a carbon tax or emissions trading scheme. Initial commentary on Australia's INDC view the existing policy measures and funding to be inadequate to achieve the emissions reductions required.1 For example, the Climate Institute has calculated the cost of meeting the 2030 target through Direct Action at $16 billion, assuming a price for abatement of $60/tonne.2 3. ERF - more projects and evolving rules As noted above, under the ERF registered projects may carry out carbon emissions reduction or sequestration projects in order to generate credits (Australian Carbon Credit Units or ACCUs), which the proponent can then bid to sell to the federal government, using a 'reverse auction' process (more akin to a tender process). If successful in the auction, the proponent contracts with the ERF administrator, the Clean Energy Regulator (CER), for the sale of the ACCUs, on agreed terms which will generally be based on the standard form carbon abatement contract issued by the CER. ACCUs are then delivered to the CER in accordance with an agreed delivery schedule in return for the agreed price. According to the CER, the average price paid by the government at the first auction was AUD 13.95 per tonne of abatement, over 144 projects carried out by 107 proponents, for an estimated 47 million tonnes of abatement (although we note the Labor opposition disputes this calculation and has argued the cost per tonne was considerably higher). The Government has indicated that it is aiming to purchase future abatement at a lower cost, particularly with the adoption of a number of new methodologies across a range of industrial sectors since the first auction. 1 see for example RepuTex Update, The Road to 2030 - The Shift from Fugitives & Clean Coal (28 August 2015) 2 The Climate Institute Australia's Upcoming Pollution Reduction Target: How to make sense of it (June 2015) 6 Deep Dive: Climate Change Policy and the Australian Market September 2015 New methods and other developments In the period since its inception as the Carbon Farming Initiative and evolution into its current form, opportunities to participate in the ERF have continued to expand. Moving beyond the initial focus on specific projects in the agriculture, waste and land sectors, a wider range of land-based and industry-specific projects are now eligible to participate, provided they can comply with the relevant technical method (or methodology) for that project type. ERF projects are broadly in one of two project types - emissions avoidance projects, and land-based projects. For emissions avoidance project types, the methods introduced since the first auction include those for projects involving gas projects (destruction/capture of fugitive emissions, in addition to the existing method for waste coal mine gas) and commercial lighting efficiency improvements, as well a 'facility method', which will encompass emissions reductions from multiple activities at large facilities for which data is reported under the National Greenhouse and Energy Reporting (NGER) scheme. Recent additional land-based project methods include those for soil carbon sequestration, fertiliser use efficiency in irrigated cotton, and reforestation and afforestation projects (replacing an earlier method). A number of draft methods have also recently undergone public consultation, including methods for landfill biofilters, beef cattle herd management, high efficiency commercial appliances, high efficiency fan installations, and refrigeration and ventilation fan upgrades as well as a varied industrial energy efficiency method. The ERF framework has been subject to almost continual development since its introduction, primarily to effect the transition from the CFI, as methods are introduced and refined, and as the CER works through practical issues arising. As part of the reform of the CFI and implementation of the ERF, the Government has amended (and in some cases, revoked and replaced) the methods that were in place as at 1 July 2015 for consistency with the ERF principles and rules. Existing CFI projects were transitioned into the ERF automatically and had the choice of continuing with the original version of the relevant project method, or opting to seek approval to use another, current method. Now in force since December 2014, the early days of the ERF have seen a number of practical risks and issues associated with participation arise. The CER issues regulatory guidance material in relation to specific methods. This guidance may include information that is essential for understanding of or compliance with the relevant method, but which is not clear on the face of the method determination. It is important for proponents to identify and consider any relevant regulatory guidance to ensure full compliance with the ERF rules and limit any risk of jeopardising the project's ERF eligibility (or breaching the legislation). The second ERF auction has been scheduled for 4-5 November 2015, with new project registrations having closed on 18 September. Particular issues for new ERF proponents to note include those around contracting with the CER to sell credits, permanence period requirements, and eligibility requirements and ideal project structuring. 7 Deep Dive: Climate Change Policy and the Australian Market September 2015 Those already familiar with the ERF should note the CER released new auction guidelines, along with a revised standard terms contract. The revised contract does not differ materially from the version used in the April auction, but has been revised in respect of delivery period mechanics, the rights of a seller's authorised representative, confidentiality around pricing and other more minor changes/corrections. ERF Contract While the carbon abatement contract is based on standard terms, it is still up to the proponent to determine and negotiate its preferred delivery schedule, as well as any appropriate risk management provisions such as conditions precedent to performance. Key to compliance with the contract is, of course, delivery of promised ACCUs to the Government in accordance with the contract. If a delivery shortfall occurs during the contract term that is not contemplated by the contract, it must be remedied in accordance with the process set out in the contract. In this event, the contract permits the delivery schedule to be amended, but does not permit any change in the number of ACCUs required to be delivered, or delivery of ACCUs after the end of the contract term. If a revised delivery schedule is not agreed and/or ACCUs are not delivered as scheduled, the proponent may be liable to pay to the CER 'market damages' equivalent to the market value of the undelivered ACCUs, plus interest and costs. If there are unmet ACCU relinquishment obligations in respect of a project after it ends - e.g. where carbon stocks have not regenerated after a fire, or if there is some incomplete or improper transfer or termination of the project, the government may impose a carbon maintenance obligation on land, which prevents destruction of carbon stocks on the land which have been credited and which may significantly affect the future use of the land, until lifted. The standard contract does contain some flexibility, including the ability to deliver ACCUs in advance of the scheduled delivery date, as well as permitting a delivery shortfall during the contract term of up to 20% (provided the shortfall is rectified by the end of the term/earlier termination). If the proponent registered for the project is not the only party in control of delivery of ACCUs under the contract, the proponent should aim to ensure it is protected against breach of the carbon abatement contract via back-toback arrangements with the other party or parties. Permanence For land-based projects, the ERF imposes obligations regarding the permanence of the emissions removals, in order to limit the risk of release of carbon from vegetation or soils before the carbon sequestration benefit is realised. The impacts of the permanence requirements should be considered carefully when contemplating a new project. Under the CFI, sequestration projects were subject to a 100-year permanence period requirement - however, due to concerns regarding impacts of this somewhat lengthy period on future holders of the affected land, the ERF enables land-based projects to select either a 100 year or 25 year permanence period. Existing projects 8 Deep Dive: Climate Change Policy and the Australian Market September 2015 can apply to reduce a 100-year permanence period to the 25 year option before December 2016. Projects opting for the shorter permanence period are subject to a 20% reduction in credits for which the project is eligible, which is intended to reflect the potential cost to government of replacing carbon stores after the project ends. This is in addition to the 5% 'risk of reversal buffer' which applies to all land-based projects and is intended to insure against temporary losses of carbon stocks as a result of natural disturbances (e.g. fire) and third party impacts on carbon stocks (i.e. impacts outside the proponent's control), as well as losses from proponent breaches which cannot be remedied. If a fire or other natural event occurs in the project area and results in a decrease in the amount of carbon stored, regrowth is required to be managed to allow the carbon stocks to replenish, or the proponent may elect to return equivalent credits to the CER. Legal right/eligibility There are a number of strict requirements for projects to be eligible for registration under the ERF, including those relating to rights over the project and the ACCUs it generates. The CFI originally required that a land-based project proponent actually owned the land, or the relevant carbon property right in order for the project to be eligible - clearly a hurdle for many projects, particularly those involving more complex corporate land and asset ownership structures. The ERF has resolved this rigidity to an extent, requiring that the project proponent demonstrate only it holds the "legal right" to carry out the project. Although more simple to satisfy than the original requirement, it can still be difficult to ensure the legal right to carry out the project is held by the correct entity in the corporate structure, particularly if that entity is not the registered owner of any relevant land or the owner or operator of the relevant facility. Sequestration projects may also be required to obtain the consent of 'eligible interest holders' - such as the landowner, any mortgagee, and/or the State for State or Crown land - in order to register for the ERF. Lowest cost abatement Successful participants in the ERF auction process are those who have or will achieve emissions abatement at the lowest cost. As borne out by the results of the first auction, under which the successful bidders were dominated by landfill gas and avoided clearing projects, this may naturally disadvantage projects such as those under the reforestation or savanna burning methods, which are less likely to be able to achieve lowest cost abatement when compared to more established and/or cost-effective methods. Additionality for facilities - extended to financial additionality All ERF projects are subject to a regulatory additionality test, which means the project cannot be required under an Australian law at any level, unless the relevant method provides otherwise. However, the nature of this test may differ between methods. Notably, the new facilities method (referred to above) involves an extended additionality test, under which projects intending 9 Deep Dive: Climate Change Policy and the Australian Market September 2015 to use that method must demonstrate that a project needs credits in order to proceed (i.e. in order to be financially viable) - which, given the likely large scale of such facilities projects relative to the value of ERF credits they can generate and sell, may exclude many projects from participating under this method. 4. Will I be caught by the Safeguard Mechanism? The Mechanism will apply to facilities with direct emissions of more than 100,000 tonnes CO2e annually. It is earmarked to commence on 1 July 2016, though the rules (released in draft on 2 September and originally slated to be in place by 1 October 2015) are now expected to be finalised in late 2015. Affected facilities must keep emissions below the assigned baseline. Broadly, baselines will be calculated based on the company's highest level of emissions in the five5 years preceding 2013/14 - however there are a number of exceptions, depending on the particular sector involved and the existence of "special circumstances" (e.g. the facility's baseline can be revised up temporarily where there has been an increase in production capacity exceeding 20% or, for a capacity increase of less than 20%, where emissions intensity has decreased despite an increase in absolute emissions, and also where previous emissions did not reflect a business as usual scenario). This reflects the Government's key objective of accommodating business growth. Affected emitters will also be able to take advantage of multi-year averaging, whereby the facility can exceed baseline in one year provided average emissions over the current three-year period remain below the baseline. Where emissions exceed the imposed baseline, the emitter will be required to purchase ACCUs equivalent to the exceedance, or incur penalties up to $1.8 million or be subject to other enforcement action. New facilities which do not have the requisite five years of emissions data will establish a baseline by an audited emissions forecast provided by the facility operator. The Government has stated that the Safeguard Mechanism is intended to ensure emissions reductions purchased by government are not offset by significant emissions increases elsewhere in the economy (rather than being intended to directly reduce emissions). RepuTex Carbon estimated in early August that this would cover 261 facilities controlled by 80 companies, although it also noted that only 85 of these facilities (run by 30 companies) would be expected to face compliance obligations.3 As noted above, individual facility baselines are to be set at the highest level of reported emissions over the years 2009-10 to 2013-14; however the government has stated that for a subset of mining, oil and gas projects, the baselines may be adjusted to better reflect business as usual emissions, in recognition of the impact of the Mechanism may have on projects involving a nature resource or reserve which will directly affect emissions performance and over which the facility has limited control. 3 RepuTex Update: ERF Safeguards - Toothless Tiger or Hidden Dragon (2 August 2015). 10 Deep Dive: Climate Change Policy and the Australian Market September 2015 Following the release of the draft rules, Reputex estimated the Mechanism would result in covered emissions increasing by around 20% to 2030. The framework also includes an initial sector-wide baseline for gridconnected electricity generators which may form the basis of a sectoral submarket for credit trading between generators. For this element, individual generator baselines will supplant the sector baseline if the sector baseline is exceeded. This sector baseline has been set by reference to total direct emissions in 2009/10, which translates to 198m tonnes annually. The waste sector is also afforded different treatment in respect of waste deposited after the Mechanism begins. Commentators such as Bloomberg New Energy Finance and the Carbon Market Institute have noted there is currently no clear ability to implement a gradual reduction of emissions baselines, which reduces long-term certainty for investors (and which is likely to inhibit the ability of the ERF to contribute towards the achievement of Australia's INDC), and no clear disincentive for facilities to take measures to obtain as high a baseline as possible. Achieving Australia's emissions reduction targets is also a more tenuous proposition where baselines are set conservatively (i.e. set high), making it easier for facilities to keep emissions below the baseline and reducing the ERF-driven incentive for emissions reduction measures (particularly where emissions have fallen over that period, as they have for the majority of facilities). This creates some uncertainty for business, which may take the view that the Mechanism is likely to change within the short to medium term if Australia's INDC is to be achieved. As noted above, we expect the Safeguard Mechanism rules to be finalised by the end of the year. However, the draft rules provide for a review of the Mechanism as part of the broader ERF review required in 2017-18, creating a further element of uncertainty for affected businesses seeking to define their long-term emissions reduction strategy. The rules may also yet be disallowed in the Senate. 5. Will there be opportunities to use international credits? Australia's INDC is silent on the use of international credits. Comments from the Prime Minister and Minister for Foreign Affairs in interviews following the release of the INDC indicate that they view Australia's target as achievable without needing to access international units but remain open to the possibility of international credits being used to meet future targets. A number of business organisations are urging the Government to keep the option to use those units available. Indeed, the Government has recently reached agreement with some participants in the waste sector about the use of forward carbon prices collected under the CPM to purchase international credits.4 Under the arrangements some waste companies that are signatories to a voluntary protocol developed to deal with the use/refund of the tens of millions of dollars collected for future liabilities from 4 CE Daily Revealed: Hunt to Use international credits to hit targets (29 June 2015) 11 Deep Dive: Climate Change Policy and the Australian Market September 2015 landfill sites will purchase certified emission reduction units (CERs) from clean development mechanism (CDM) projects (currently trading at approximately $0.80) and transfer them to the Government to acquit the need to refund monies directly to customers. As a result of the above waste transactions, the Australian Government will accumulate a holding of CERs which it will be able to carry over to assist in meeting its obligations under the Kyoto Protocol's second commitment period and possibly its INDC. We also note that the recently released draft rules for the Safeguard Mechanism state that the Government will, as part of the 2017-18 review of the ERF, consider the role of high quality international credits in assisting large emitters meet their baselines. This leaves open the possibility that businesses will be able to manage future liability through carbon trading - a move that will effectively put a price on carbon. 6. What if I already hold international units in the Australian Registry? The Australian Registry of Emissions Units (ANREU) allows account holders to import and export Kyoto units (e.g. CERs). Only a small number of companies have actively dealt with CERs - primarily banks and trading houses who had a view to supply those credits to liable entities under the CPM in the period after 1 July 2015 when those units were to become eligible for domestic compliance. Under the Kyoto Protocol rules, Australia is entitled to carry over CERs from the first commitment period (CP1) to the second commitment period in an amount which represents up to 2.5% of Australia's assigned amount for CP1. This equates to approximately 74 million CERs. Australia can also carry over unlimited surplus assigned amount units (AAUs). In July 2015 the Government released a consultation draft Regulation to address the carry over of international units. The draft Regulation proposes that only AAUs, CERs and ERUs from CP1 held in the Commonwealth’s holding account can be carried over at the end of the true up period (being the period during which the greenhouse accounts of Parties to the Kyoto Protocol are reconciled - ending on 18 November 2015). This means that any private person holding CP1 Kyoto units in the Australian registry at the end of the true-up period will have those units transferred to the mandatory cancellation account. The Explanatory Statement to the draft Regulation states that the “Kyoto carryover rules are designed to help Parties (to the Kyoto Protocol) manage the cost of reducing emissions over time.” That is, the Australian government sees the international rules as being for the benefit of the Party, rather than private entities that may participate in the Kyoto flexible mechanisms. Beyond this, the Explanatory Statement does not provide any clear rationale for the proposed approach. However, we expect that, despite the low number of persons holding Kyoto units in ANREU, the administrative burden of apportioning carry over quotas was considered too high. 12 Deep Dive: Climate Change Policy and the Australian Market September 2015 We anticipate that, in order to maintain flexibility to achieve its commitment under the Kyoto Protocol's second commitment period, the Australian government will seek to take full advantage of its ability to carry over CP1 Kyoto units. It has also been reported that consideration is also being given to the government accepting transfers of CERs from major waste companies as part of a settlement deal to address the fact that many of those companies had levied future carbon charges on customers under the CPM. Accordingly, there may still be a limited market for CP1 CERs in Australia prior to the end of the true up period. 7. Are there opportunities for Australia to connect with international carbon markets? In the period 2008-2013, Australia was very proactive in its support for emission trading and linking to regional and international carbon markets. Australia legislated for a link between the Australian Carbon Price Mechanism (CPM) and the EU ETS; actively promoted the development of, and access to, market based mechanisms in the UNFCCC; and supported initiatives such as the World Bank's Partnership for Market Readiness. With the repeal of the CPM, the potential for direct international carbon trading has diminished significantly. Under the Abbott Government and with the removal of the CPM, there was very little support or need for participation in international emissions trading or utilising international offsets. However, it would appear that the position regarding the use of international offsets is shifting with the Waste Industry Voluntary Protocol, although the role international offsets would play more broadly remains to be clarified. Use of international credits in meeting future industry baselines may be one possibility. This notwithstanding, the Government has provided funding to assist countries in the Asia-Pacific region to pursue activities designed to reduce emissions from deforestation, forest degradation, forest conservation and the sustainable management of forests and enhanced forest stocks (REDD+). The adoption of international rules to govern REDD+ at recent COPs is providing greater certainty for project and programme development in this area. With REDD+ forming a central element of the INDCs being put forward by a number of countries in the Asia-Pacific region, it may well be through Australian engagement with those activities that we see implicit support for carbon markets. 8. What is the opposition's policy? The Labor opposition has criticised the stringency of Australia's INDC. While it has not put its own proposal on the table, it has generally endorsed the views of the Climate Change Authority that more could be done at minimal cost to the Australian economy. At its recent national conference, Labor reaffirmed its commitment to pricing carbon. The opposition environment spokesperson has indicated that he will be consulting on the design elements of an ETS. In addition, the leader of the opposition has expressed an aim to see 50% of Australia's energy come from renewables by 2030. 13 Deep Dive: Climate Change Policy and the Australian Market September 2015 If Labor were elected at the next election (due before November 2016) an important policy consideration would be how to transition existing climate policy under Direct Action to a new ETS. We would expect that any existing contracts issued under the ERF would be honoured and compliance with a Safeguard Mechanism (if commenced) would run it course for its initial compliance year and until such time as new policies had been legislated. What this means for businesses is continued uncertainty over the next few years and likely additional investment in time and resources to respond to the changing policy landscape. 9. Conclusions: Key observations and things to think about • A global agreement in Paris It is likely that agreement will be reached on a new climate change treaty for the period post-2020. That agreement will include significantly more ambitious emission reduction targets for developed countries and obligations for developing countries to also contribute to emissions reduction or limitation. These targets are expected to lead to a fundamental shift in economic systems, with many countries, including some of Australia's major trading partners, pursuing low-carbon development pathways and increasing the use of renewable energy. This provides opportunities for businesses in the clean energy sector. It also may lead to market constraints for some fossil fuel producers if their export markets are adopting policies that limit fossil fuel use or which impose carbon prices. • Global momentum on climate action is building Internationally there has been a significant shift in the approaches of a number of developed and developing countries to climate change. In the lead up to Paris we have seen countries such as China and the US take the lead in framing climate change as an issue which needs immediate attention and which can be addressed through energy reform. This movement is building quickly and Australian companies may be left behind if domestic policies continue to prioritise conventional energy sources and do not actively promote the development of more carbon competitive industries. • Emerging carbon markets A number of countries in the Asia-Pacific region have established emissions trading systems and are imposing a price on carbon (e.g. South Korea, China, US States, Canadian Provinces, New Zealand). These systems will enable those countries to address their climate change commitments in a more flexible manner. Over time, those markets may look to recognise high quality international offset credits. Australia will need to think about how it is placed to engage with these markets. • Meeting Australia's INDC Australia has committed to an emission reduction target for 2030 but there is real uncertainty about way forward. More effort than is currently proposed will be needed to meet the target. This is likely to result in new and additional climate policies to be developed in the coming years. This could lead to delays and uncertainty regarding its implementation. The 14 Deep Dive: Climate Change Policy and the Australian Market September 2015 Labor Party clearly has a different approach to addressing climate change. If it were to win the next election we would likely see a few more years of policy uncertainty whilst new, yet to be determined, laws and regulations are considered and enacted. • ERF tips and traps In the lead up to the second auction on 4-5 November, new projects must be registered by 18 September 2015. Particularly for those projects who participated in the first round in April, proponents should review the recently released auction guidelines, and note the revised standard contract for the purchase of ACCUs. Given the detailed and prescriptive nature of the registration and auction processes, we recommend early preparation and planning for participation in the second auction. All projects should monitor the CER website to ensure any regulatory guidance released by the CER in relation to the specific method being used has been identified and considered, remembering that guidance often contains essential information for proponents which is not contained the applicable method. • Safeguard Mechanism and review uncertainty With the release of the draft ERF Safeguard Mechanism rules, impacted emitters are in a position to start assessing its likely impacts on operations, including any special circumstances which may warrant a modified emissions baseline. However, there are still major uncertainties associated with the Mechanism which will hinder businesses seeking to determine their approach to the Mechanism and its impacts for their operations, including whether the rules will be accepted in the Senate, any surprises in the final form of the rules, and what further changes might flow from the 2017-18 review of the Mechanism. We note that the new Prime Minister has indicated his support for the existing Direct Action plan architecture. • Domestic carbon pricing The evolution of the ERF and Safeguard Mechanism will ultimately result in a de facto carbon price being imposed on the Australian economy, particularly if the Safeguard Mechanism baselines are tightened or if a future Labor Government introduces an emissions trading scheme. Business needs to accept this and begin planning strategies to manage their exposure to this price. • State-level momentum building Businesses should also monitor new developments around climate change law and policy approaches by the states and territories, particularly those businesses with operations in South Australia, Victoria, the Australian Capital Territory, New South Wales and Queensland, where we are seeing the most active engagement by State Governments on these issues. www.bakermckenzie.com For further information please contact Martijn Wilder AM +61 2 8922 5276 Martijn.Wilder@bakermckenzie.com Paul Curnow +61 2 8922 5173 Paul.Curnow@bakermckenzie.com Ilona Millar +61 2 8922 5710 Ilona.Millar@bakermckenzie.com Lauren Kirkwood +61 7 3069 6240 Lauren.Kirkwood@bakermckenzie.com Kate Phillips +61 3 9617 4454 Kate.Phillips@bakermckenzie.com Arjuna Dibley +61 3 9617 4432 Arjuna.Dibley@bakermckenzie.com Baker & McKenzie Level 27, AMP Centre 50 Bridge Street Sydney, NSW 2000 Australia ©2015 Baker & McKenzie. 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