The Carbon Tax Act 15 of 2019 (“the Act”) introduced the concept of “carbon offset allowances” as an incentive to minimise carbon tax liability. Trading in the carbon market in South Africa is not new, but it has been stagnant for the last decade. This article discusses the concept of carbon offsets in the South African context and the potential opportunities, which could result in sustainable investment, putting your company “ahead of the pack”.
The Act, which commenced on 1 June 2019, is a bold step in the national debate about what sustainable development means in the context of the nation’s economic priorities and the impact of climate change on achieving them. The preamble recognises that “the causality of the increasing of anthropogenic greenhouse gas emissions in the atmosphere and the global climate change has been scientifically confirmed” and that “it has consequently become necessary to manage the inevitable climate change impact through interventions that build and sustain South Africa’s social, economic and environmental resilience and emergency response capacity”. The Act is certainly going to have major implications in the long term for South African companies and for companies doing business in South Africa.
Carbon offsets are external investments made by emitters of greenhouse gasses (“GHGs”) in specific projects that reduce, avoid or sequester emissions (“approved projects”). Approved projects are developed and evaluated under specific methodologies and standards allowing carbon credits to be issued. Carbon offsets allow companies to access GHG mitigation options at a lower cost than investment in their current operations. Globally, carbon offsets (or carbon credits) are being employed as economic instruments to reduce GHG emissions. Trading of carbon credits takes place at both international and domestic levels.
Section 13 of the Act (read with Schedule 2) provides for mandatory carbon offset allowances. Depending on the industry involved and the activity/sector undertaken, companies will be able to reduce their carbon tax liability by using offset credits up to a maximum of 5 or 10 percent of their process or fuel combustion GHG emissions respectively. According to the Carbon Offsets Paper (April 2014, published by National Treasury) (“Carbon Offsets Paper”), carbon offsets will incentivise investment in projects that can generate considerable sustainable development benefits in South Africa, including channelling capital to rural development projects, creating employment, restoring landscapes, reducing land degradation, protecting biodiversity, and encouraging energy efficiency and low carbon growth.
Pursuant to section 19(c) of the Act (which at the time was still a Bill), a second version of the Draft Regulations on the Carbon Offset was published in November 2018 (“the Draft Regulations”) (with an explanatory note released by National Treasury). According to the explanatory note, the carbon offset system serves a dual purpose in that: “(i) it is a flexible mechanism to enable industry to deliver cost mitigation, that is, mitigation at a lower cost to what would be achieved in their own operations, and thereby lower their tax liability; and (ii) it incentivises mitigation in sectors or activities that are not directly covered by the tax and/or benefitting from other government incentives, especially, transport, Agriculture, Forestry and Other Land Use (“AFOLU”) and waste”.
According to the Carbon Offsets Paper and the Draft Regulations, to qualify as an approved project, the project will be required to comply with eligibility standards (that are still being negotiated and developed) that will rely primarily on existing international carbon offset standards, namely the Clean Development Mechanism (“CDM”) (although this may change due to the shift to the Paris Agreement from 2020), Verified Carbon Standard (“VCS”) and the Gold Standard (“GS”). A user manual will be developed under the World Bank’s Partnership for Market Readiness project. The Draft Regulations also provide the State with significant flexibility to approve other standards and methodologies (which could potentially include models such as Environmental Social Governance (“ESG”)). All projects approved under international standards will be required to meet the South African specific requirements of the carbon offsets system. The main eligibility criteria proposed are the following:
- In the first phase of the carbon tax, only projects implemented on or after the start date of the carbon tax and located in South Africa will be eligible under the carbon offset system.
- Projects should occur outside the scope of activities that are subject to the carbon tax to prevent double counting of the carbon emission reduction benefit. The carbon offset system will focus on activities that are not already included in the carbon tax net, which includes the transport, waste and AFOLU sector activities. Non-eligible projects presently covered in the draft regulation 4 include energy efficiency projects implemented on activities that are owned or controlled by companies that are covered by the carbon tax; fuel-switch projects implemented on activities that are owned or controlled by companies that are covered by the carbon tax; projects that benefit from the Energy Efficiency Savings Tax Incentive; renewable energy projects with a generating capacity exceeding 50MW; and nuclear power projects, as examples.
Carbon offset allowances in the context of the carbon tax regime will kick-start the carbon offset market in South Africa, with its mandatory demand and supply. However, a voluntary carbon offset scheme may develop which will enable companies and individuals to purchase carbon offsets on a voluntary basis outside of the carbon offset compliance market. As indicated in the Carbon Offsets Paper, the purpose of introducing a carbon tax is intended to send the necessary policy and price signals to investors and consumers to ensure that future investments are more climate-resilient. But in the South African context where there is an electricity crisis and the economy is struggling, the transition to a greener economy will need to be a gradual process that balances various stakeholders’ interests. Developing a stronger carbon offsets market in South Africa could be one of the mechanisms used to effect this transition.
The price on carbon acts as a signal that incentivises behavioural change and makes emission-reduction projects more attractive. Behavioural change is no easy task. However, change also brings opportunity. Emitters who will be liable for carbon tax could view the carbon offset market as an opportunity to invest in greener projects without having to compromise their projects. The carbon offset market will bring about major opportunities for approved projects. Investors in both carbon emitting projects and approved projects will need to reassess their investment mandates and portfolios to align with the principles guiding the carbon offset market. There are also opportunities for third parties to trade in carbon credits.
Why wait until the final version of the Regulations on Carbon Offsets is published? Proactivity is key in identifying potential opportunities for investment and capital growth in an emerging market that values sustainable development. Familiarising oneself with international and domestic models and principles that are guiding climate change initiatives such as ESG, CDM, VCS and GS is a good starting point to navigate the challenges and opportunities to ensure that your business stays ahead of the curve. Developing internal company policies based on these models and principles is key.