Australian polluters to make A$2 billion in profits from grey carbon credits

While the proposed Direct Action Plan in Australia is likely to remove or at least reduce the downside risk for the majority of Australian firms, for many companies, it remains to be seen whether the new scheme will provide enough upside potential to incentivise their participation in the new Emissions Reduction Fund (ERF).

The potential for companies to generate “abatement credits” for operating under a prescribed baseline is likely to play a key part in the government’s Green Paper on the design of the ERF, creating a supply link between the ‘baseline and penalty’ and ‘reverse auction’ mechanisms of the Direct Action Plan, and developing a financial incentive to encourage industry greenhouse gas emissions reductions, according to a new research report. 

However, while the ‘pay to reduce’ carrot makes sense in theory, in practice industry participation in the scheme will be determined by how emissions baselines will be set, how industry will receive abatement credits and how they might be bid into the ERF. 

EMISSIONS BASELINES – RISK OF A ‘GREY’ CREDIT INFLUX INTO THE ERF? 
The setting of emissions baselines will have critical implications for industry, determining the net position of each firm under the proposed ‘baseline and penalty’ scheme, and the amount of abatement credits that could be bid into the ERF from companies operating below their baselines. 

Initial forecasts indicate that under this ‘loose’ baseline scenario we would see high supply of abatement credits from industry into the ERF, leading to ERF auction prices of approximately A$13 on average in year one, rising to around A$20 on average to FY18. In such a scenario, more than 75 per cent of all credits bid into the ERF would be likely to be ‘grey’ credits – non-additional abatement credits created by an arbitrary baseline – and could potentially lead to a windfall of nearly A$2 billion over the first 4 years of the scheme as companies bid these free credits into the ERF. 

‘Green’ credits from an expanded set of Carbon Farming Initiative methodologies would supply the remaining 25 per cent of abatement into the ERF, however supply from these sources would be limited by the ability of ‘grey’ credits to bid into the ERF at lower prices. While the financial upside for industry is clear in such a situation, the design of emissions baselines and the application of ‘additionality’ rules are key issues yet to be resolved by the government.

 It is difficult to imagine the government knowingly directing resources to non-additional abatement; however, industry designing rules to completely avoid crediting their own previous efforts may be even harder to imagine. 

Given that the Direct Action Plan is unlikely to initially provide a ‘stick’ to incentivise companies to reduce emissions, industry participation will be almost entirely based on the ability of the ‘baseline and credit’ mechanism to encourage industry participation in the scheme. How baselines and penalties are set, the eligibility of sources of low-cost, large scale abatement and the design government contracts will be critical watches for the market – particularly how policy settings influence supply of abatement (from baselines and the CFI), auction prices, and each firm’s ability to bid into the ERF.

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