The Carbon Farming Initiative: removing the obstacles to its success

Transcription

1 The Carbon Farming Initiative: removing the obstacles to its success Andrew Macintosh CCLP Working Paper Series 2012/3 ANU Centre for Climate Law and Policy Sponsored by

2 About the ANU Centre for Climate Law and Policy The ANU Centre for Climate Law and Policy (CCLP) is part of the ANU College of Law. It was established in 2007 with the objective of providing a focal point for law and policy research related to climate change. The CCLP also runs courses in climate law and provides consulting services. Additional details of the CCLP can be found on its website: The CCLP gratefully acknowledges the support of its founding sponsor, Baker & McKenzie. CCLP Working Paper Series The CCLP Working Paper Series provides a forum for the presentation of initial findings from CCLP research projects. The publications are intended to facilitate the exchange of information on climate law and policy issues. Through this process, the CCLP hopes to improve its final research outputs. CCLP Working Paper Series 2012/3 corresponding author: Andrew Macintosh Ph: macintosha@law.anu.edu.au About Baker & McKenzie Baker & McKenzie provides sophisticated legal advice and services to the world s most dynamic global enterprises and has done so for more than 50 years. Our network of lawyers is amongst the world s most diverse and respected. We come from more than 60 countries and speak more than five dozen languages, including a common one, English. We are guided by a culture of integrity, personal responsibility, friendship and tenacious client service. Our unique approach enables clients to call upon more than 3,600 locally qualified, globally experienced lawyers in over 38 countries. We deliver the broad scope of quality legal services required to respond to any business need consistently, confidently and with sensitivity for cultural, social and legal practice differences. For more information about Baker & McKenzie, including details of its climate practice, please visit: ii

3 Abstract In December 2011, the Australian Government introduced the Carbon Farming Initiative (CFI), a project-based, baseline-and-credit offset scheme for emissions and removals from the land use, land-use change and forestry (LULUCF), agriculture and waste sectors. The scheme is one of the most robust of its kind, having several innovative design features developed to deal with integrity and perverse impact risks, and promote co-benefits. Despite this, there are a number of issues undermining the capacity of the CFI to realise cheap abatement opportunities and improve environmental outcomes. This paper provides an overview of the CFI and an analysis of the obstacles to its success. Suggestions for improvements are made, including substituting a flexible permanence period-permanence deduction mechanism for the existing 100 year rule and modifying the risk of reversal buffer and leakage deduction processes to improve returns to project proponents. 3

4 Introduction After almost two decades of debate, and five previous attempts, the Australian carbon pricing scheme finally commenced on 1 July While welcomed internationally, the domestic response has been mixed. Most analysts have judged the scheme to be a significant, if not a substantial, advance, an opinion influenced by the compromises that were necessary to get the scheme through Parliament and unambitious nature of Australia s likely 2020 mitigation target (5% reduction on 2000 levels) [1-5]. Within the political sphere, the response has been polarised; the Labor Government and Australian Greens have hailed it as a great leap forward, the Liberal-National Party Opposition have claimed it will be like a wrecking ball through the economy and put the a python squeeze on growth [100, 101]. In the background to the contentious carbon pricing debate has been the Carbon Farming Initiative (CFI). Like the Kyoto Protocol s Clean Development Mechanism (CDM), the CFI is a project-based, baseline-and-credit offset scheme. Under it, approved offset projects are able to generate certified offsets, called Australian carbon credit units (ACCUs), from the land use, land-use change and forestry (LULUCF), agriculture and waste sectors. Where the removals and/or avoided emissions count towards Australia s mitigation targets, the ACCUs (called Kyoto ACCUs) can be used to meet liabilities under the carbon pricing scheme or exchanged for Kyoto units (Assigned Amount Units (AAUs), Emission Reduction Units (ERUs) or Removal Units (RMUs)) and sold into overseas compliance markets. If the removals or avoided emissions do not count towards Australia s targets, the project is known as a non- Kyoto offset project and receives non-kyoto ACCUs, which can only be used in voluntary markets. Conceptually, the CFI shares much in common with other carbon offset schemes. What makes it of international interest is its breadth, the statutory framework within which it operates, and, most notably, the innovative design features developed to deal with integrity and perverse impact risks, and promote co-benefits. In drafting the Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) (CFI Act), the Australian Government made particular efforts to respond to concerns that the scheme would suffer a failure to thrive due to the transaction costs that stem from project-level integrity requirements [6]. Despite this, the scheme faces a number of potential obstacles and concerns still linger that the CFI may not realise its full potential [7]. The object of this article is to review the design features of the CFI, analyse the impediments to its success and identify potential solutions. The following section provides an overview of the CFI. The article then reviews the mechanisms included within the CFI to deal with integrity and perverse impact risks, and to promote cobenefits. This is followed by an analysis of the obstacles to the scheme s success, conclusions and a future perspective. Overview of the CFI The policy package that took effect in July 2012 the Clean Energy Future package has three main components: the CFI, an emissions trading scheme (with a three year fixed priced period) and a collection of equivalent carbon prices (i.e. carbon taxes). The premise behind the design of the package was that most of Australia s emissions and removals should be subject to a direct or equivalent carbon price, or 4

5 fall within the reach of the CFI [6]. The Clean Energy Act 2011 (Cth) (CE Act), which contains the emissions trading scheme, imposes a direct carbon price on selected emissions from the energy, industrial processes and waste sectors. To fill gaps left by the CE Act in the energy and industrial processes sectors, equivalent carbon prices are imposed on certain emissions from these sectors via the fuel tax and ozone and synthetic greenhouse gas regulation regimes. A significant proportion of the remaining gaps in the coverage of Australia s emissions and removals from the agriculture, waste and LULUCF sectors are supposed to be filled by the CFI. As noted, the CFI divides projects and ACCUs into Kyoto and non-kyoto based on whether the avoided emissions or removals are reported against Australia s mitigation targets. It also splits projects into sequestration and emissions avoidance projects. Sequestration projects are those whose emissions and removals are accounted for in the LULUCF sector. They involve the sequestration of CO 2 in biomass or soils and avoidance of CO 2, CH 4 and N 2 O emissions from the destruction or disturbance of biomass or soils. Emissions avoidance projects are those whose emissions are accounted for in the agriculture and waste sectors the avoidance of CH 4 and N 2 O emissions from agricultural activities (e.g. livestock, rice production, savannah burning and crop residue burning) and legacy waste in landfill facilities (i.e. CH 4 and N 2 O emissions from waste accepted at a landfill facility before 1 July 2012). The CFI also provides for emissions avoidance projects involving feral animals (known as introduced animal emissions avoidance projects ). CH 4 and N 2 O emissions from feral animals are not provided for under current international accounting rules because they are non-anthropogenic. Despite this, the CFI allows for non-kyoto ACCUs to be generated for projects involving the avoidance of these emissions. The project types and coverage of emissions under the CFI is summarised in Table 1. Table 1 Relationship between sequestration and emissions avoidance projects, and Kyoto and non-kyoto projects* Kyoto offset projects Non-Kyoto offset projects * Adapted from [6]. Carbon sequestration Sequestration projects on lands accounted for by Australia under the Kyoto Protocol. In the first commitment period, this was confined to afforestation/reforestation and deforestation. Sequestration projects on lands not accounted for by Australia under the Kyoto Protocol. Emissions avoidance Agricultural emissions avoidance projects = projects to avoid CH 4 and N 2 O emissions from savannah burning, grassland burning, crop residue burning, agricultural soils, and livestock urine and dung, and CH 4 emissions from livestock and rice production. Landfill legacy emissions avoidance projects = projects to avoid CH 4 and N 2 O emissions from waste deposited in landfill prior to 1 July Introduced animal emissions avoidance projects = projects to avoid CH 4 and N 2 O emissions from introduced animals. The five steps associated with the issuance of ACCUs under the CFI are summarised in Table 2. 5

6 Table 2 Steps in generating ACCUs No. Step Nature of requirement Responsible authority 1 Approval of methodology 2 Approval as a recognised offset entity 3 Approval of eligible offset project Provide the basis for determining the number of ACCUs that a project generates and can include specific project requirements (e.g. reporting, incident notification, record-keeping) All persons wanting to undertake a CFI project must be a recognised offset entity For a project to generate ACCUs, it must be approved as an eligible offset project. The major requirements are that: the applicant must be responsible for carrying out the project and have the legal right to undertake it the project must meet the additionality test the project must not be on the negative list For sequestration projects, o the project must not involve the clearing of native forest or use of material obtained as a result of the clearing or harvesting of native forest o the applicant must hold the applicable carbon sequestration right o all people with interests in the land must have consented to the application 4 Reporting Project proponents must prepare and submit offset reports within three months of the end of a selfselected reporting period of between 1-5 yrs 5 Crediting After submitted an offset report, a proponent can apply for a certificate of entitlement, which triggers the issuance of ACCUs All methodologies must be endorsed by the Domestic Offsets Integrity Committee (DOIC) then approved by the Minister for Climate Change Clean Energy Regulator makes decision on basis of whether applicants are a fit and proper person Clean Energy Regulator must be satisfied the project meets the statutory and regulatory requirements The offset reports are required to be submitted to the Clean Energy Regulator (usually they must be audited prior to submission) Clean Energy Regulator is responsible for calculating the unit entitlement for the project and issuing the ACCUs Integrity and perverse impact risks, and capturing co-benefits Like tradable permit schemes (e.g. emissions trading schemes), the main benefit associated with offsets is that they lower abatement costs [6, 8-9]. Many offset types also have the capacity to generate co-benefits [10-16]. For example, carbon offsets involving reforestation can have positive impacts on biodiversity, heritage and hydrology, as well as sequestering carbon. These characteristics have made offsets an attractive policy option, particularly in relation to the mitigation of greenhouse gas emissions, where many view sequestration-related offsets as a way of buying time for the development of zero- and low-emission energy sources [7, 17-18]. While offering several benefits, offsets come with risks. In carbon offset schemes, the risks can be split into two groups: integrity risks and perverse impact risks. 6

7 Integrity risks Integrity risks relate to the potential for the actual abatement associated with an offset to be less than its face value (i.e. the offset is supposed to embody 1 tco 2 -e of abatement but the actual abatement is only 500 kg). In carbon schemes, the main integrity risks stem from additionality, leakage and permanence [19-22]. Concerns about these issues has stifled the use of offsets in domestic schemes (most notably in the European Union s Emissions Trading Scheme), led to restrictive rules on reforestation and afforestation projects in the CDM, and hindered the creation of an international offset scheme for deforestation and forest degradation in developing countries [23-26]. In most climate offset programs, if the offset credits do not represent their face value in abatement, the environment bears the cost the use of the offset results in higher net emissions and a higher atmospheric concentration of greenhouse gases. The same applies with non-kyoto ACCUs under the CFI but not necessarily with Kyoto CFI projects. If Kyoto ACCUs do not represent their face value in abatement, the impacts will usually be financial rather than environmental [6, 27]. This is a product of the fact that Australia s emissions are subject to a national cap under the Kyoto Protocol. Where Kyoto ACCUs are issued for non-existent abatement, Australia s net emissions will be unchanged, meaning there should be no change in the environmental outcome. What will change, however, is that, to account for the relative increase in emissions from the sectors that fall outside of the carbon pricing scheme (the so-called uncovered sector emissions ), the carbon pollution cap under the CE Act will have to be lowered, thereby reducing the revenues received for carbon units issued by the Australian Government. Alternatively, if the carbon pollution cap is not reduced, the Australian Government will be required to purchase offsets from overseas. Either way, defects associated with the abatement value of Kyoto ACCUs will usually lead to the Government incurring costs or forgoing carbon revenue. This provides an inbuilt incentive for the Australian Government to minimise integrity risks, a fact reflected in the mechanisms that have been built into the CFI to deal with these issues. Additionality mechanisms Additionality refers to the risk of offset credits being issued for emission reductions or enhanced removals that would have occurred anyway [6, 28-30]. The CFI has two main mechanisms for dealing with this issue: the additionality test and the baseline and measurement requirements. The additionality test is aimed at excluding projects that would have occurred without the incentive provided by the capacity to generate ACCUs. It applies to the approval of methodologies (methodologies cannot be approved unless the projects covered by the method will pass the test) and eligible offsets projects (projects cannot be approved as eligible offsets projects unless they pass the test). Other carbon offset schemes, including the CDM, use a project-level additionality test, which requires an assessment of whether each project would have been undertaken in the counterfactual. Although considered initially, this approach was discarded in preference for a project-type test based on two requirements: the projects must be included on a so-called positive list contained in regulations; and 7

8 projects must not be required under a law of the Commonwealth, or a law of a state or territory. The positive list is intended to include activities that are not common practice within an industry or region 1 if the practice is not common, it is presumed that it would not have been undertaken without the incentive provided by the CFI [31]. At the time of writing, the list consisted of 15 broad project types, including the establishment of permanent plantings (reforestation), avoided regrowth clearing (deforestation), capture and combustion of CH 4 from legacy waste (waste), and early dry season burning of savannah areas and reduction of emissions from ruminants by manipulation of their digestive processes (agriculture). 2 The Government s intent in using a project-type test was to reduce transaction costs [6, 31]. The downside of this approach is the ease with which legitimate projects can be excluded and non-additional projects included. This is partly due to the breadth of the powers to make and modify the positive list. The list is embodied in regulations made under the CFI Act, which can be remade at any time by the Governor-General at the direction of the climate minister. Other than the requirement that projects fall within the broad statutory definitions of emissions avoidance or sequestration offset projects, there is effectively no restriction on what can be included on, or excluded from, the list. 3 Regulations can even be made waiving the requirement that a project not be required under a law of the Commonwealth or a state or territory. In some respects, the flexibility inherent in the additionality test is strength as it allows the list to be adapted to particular events and to evolve with land use and waste management practices. However, it also leaves it open to manipulation. Some of the risks associated with the project-type additionality test can be addressed by the baseline and measurement requirements. Under the CFI Act, all methodologies must provide for the setting of project baselines calculated on the assumption that the project was not carried out. 4 The methodologies are also required to meet specified offsets integrity standards, including that relevant emissions and removals be measurable and verifiable, that all estimates, assumptions and projections be conservative, and that the methods be supported by relevant scientific results published in peer-reviewed literature and consistent with those in Australia s National Inventory Report. 5 Hence, even if a suspect project passes the additionality test, its capacity to generate ACCUs should be limited. 1 CFI Act, s 41(3). 2 Carbon Credits (Carbon Farming Initiative) Regulations 2011 (CFI Regulations), reg Before regulations are made concerning the list, the minister must consider advice from the Domestic Offsets Integrity Commission and have regard to whether the project type is common practice, or would not be common practice but for the incentive provided by ACCUs (CFI Act, s 41). However, these are procedural requirements and do not impose substantive restrictions on the content of the regulations. 4 CFI Act, s CFI Act, s 133(1). 8

9 Leakage mechanism Leakage refers to the risk that an offset project will trigger an increase in emissions from sources, or reduction in removals by sinks, that occurs outside the project boundary, thereby reducing the associated net abatement [6, 19-20, 28]. Unlike the other integrity risks, there is the potential for leakage associated with Kyoto ACCUs to have adverse environmental impacts. Where there is leakage from a Kyoto (or non- Kyoto) offset project into a country whose emissions are not subject to a national cap, there will be a relative increase in global emissions. However, this risk is not unique to CFI projects. Mitigation in any trade exposed sector has the capacity to lead to leakage of this nature [19]. To the extent there is domestic leakage from a Kyoto offset project, the impacts are purely financial. Because of the existence of the national cap, and the fact that the relevant emissions and removals fall within it, leakage from a Kyoto offset project should not change Australia s net emissions outcome; it merely changes the spatial and/or temporal distribution of emissions by causing a relative increase in uncovered sector emissions. The main mechanism for dealing with leakage under the CFI is the methodologies. The CFI Act s offset integrity standards require all methodologies to provide for a deduction to be made in calculating a project s credit entitlement to account for greenhouse gases that are emitted from any source or sources as a consequence of carrying out the project. 6 Permanence Permanence concerns the risk associated with sequestration projects that the carbon stored within the project area in biomass or soils will be fully or partially released as a result of future events (e.g. wildfires, drought and deliberate clearing of the vegetation) [6, 19-22, 28]. Three mechanisms were built into the CFI to deal with this issue. First, a risk of reversal buffer (usually set a 5% of a project s credits) is required to be deducted from all sequestration projects. Secondly, all sequestration projects are required to maintain the relevant carbon stores for 100 years (known as the 100 year rule ), or another period set by regulation. Thirdly, the offsets integrity standards require that methodologies be conservative and include provisions to account for significant cyclical variations in the amount of carbon sequestered in the relevant carbon pool on the project area over the 100 year period (or the alternative period set in the regulations). 7 Perverse impacts Perverse impact risks refer to secondary adverse impacts associated with offset projects. With the CFI, much of the public debate surrounding perverse impacts has concentrated on potential negatives associated with forestry projects, particularly monoculture plantations and their capacity to have adverse hydrological, wildfire, biodiversity and socio-economic affects [6]. After the introduction of tax incentives for plantations in the 1990s (called forestry managed investment schemes ), there was a large increase in reforestation in parts of southern Australia and isolated areas 6 CFI Act, s 133(1)(e). 7 CFI Act, s 133(1)(f). 9

10 in the north. A significant proportion of the reforestation was in the form of monoculture plantations. These plantations attracted controversy and were opposed by many because of their impacts (perceived and real) on rural communities and the environment. Farm lobby and environmental groups expressed concern during the initial deliberations over the CFI that the scheme could lead to the permanent retention of the existing plantations and spread of similar monocultures across the landscape [6]. The CFI Act contains several mechanisms for dealing with these and other potential perverse impacts, the most important of which is the power for regulations to be made prescribing excluded offset projects (known colloquially as the negative list ). This purpose of the list is to exclude projects that could have significant adverse impacts on water availability, biodiversity conservation, employment, local communities, and land access for agricultural production, or that could otherwise undermine the efficient operation of the scheme. At the time of writing, the list consisted of seven project types, including the planting of weed species, establishment of a forestry managed investment scheme, avoiding harvest of a plantation and revegetation of illegally cleared land. 8 The negative list is complemented by three other perverse impact management mechanisms: projects must not involve the clearing a native forest or using material obtained from clearing or harvesting a native forest; 9 projects are required to have all necessary Commonwealth, State and Territory regulatory approvals concerning land use and development, water and the environment; 10 and the Register of Offset Projects must note whether a project is consistent with any applicable regional natural resource management plan. 11 Capturing co-benefits As noted, some offset projects have the capacity to generate co-benefits related to the environment and other dimensions of sustainable development. In order to promote projects that are likely to generate these benefits, the CFI Act allows for these attributes to be noted on the Register of Offset Projects. The Register must include details of all eligible offset projects and, at the request of the proponent, it can also include information on their environmental or community benefits, provided the requested information meets requirements prescribed in the regulations. 12 Although still to be released, the Government has indicated it will develop a co-benefits index that will be used to rate and record the co-benefits of projects on the Register [31]. These mechanisms are designed to facilitate the creation of a market for premium ACCUs, much like the CDM s Gold Standard [32]. 8 CFI Regulations, regs 3.36 and CFI Act, s 27(4)(j). 10 CFI Act, s CFI Act, s 168(1)(i). 12 CFI Act, s168(1)(o). 10

11 Obstacles to the success of the CFI The primary objective of the CFI is to lower the costs associated with meeting Australia s mitigation commitments by realising cheap abatement opportunities in the sectors that are not subject to a carbon price. Other secondary aims are to increase abatement in ways that are consistent with the protection of the environment and that improve resilience to climate change, and to encourage offset projects in sectors that are not counted towards Australia s emissions total. Although the CFI has many admirable design features, a number of issues could threaten the uptake of CFI projects and stifle the capacity of the scheme to achieve its aims. These can be grouped under four headings: carbon price uncertainty; transaction costs; and integrity- and perverse impact-related restrictions. Carbon price uncertainty The success of the CFI is dependent, to a large extent, on the existence of a secure source of demand. Under the existing policy framework, demand for Kyoto ACCUs is provided by the carbon pricing scheme and, potentially, international compliance markets. Demand for non-kyoto ACCUs is intended to be provided by voluntary carbon markets and the Australian Government s Carbon Farming Initiative non- Kyoto Carbon Fund, a six year AU$250 million fund that was established with the sole purpose of purchasing credits from non-kyoto projects. As alluded to in the introduction, the Liberal-National Party is opposed to the carbon pricing scheme has promised to repeal it if it wins the 2013 federal election. Under their existing policy, the CFI would remain, with demand for both Kyoto and non- Kyoto ACCUs being provided by a government fund and voluntary markets. At the time of writing, the Opposition had provided few details of the fund or what projects might be eligible to participate in its scheme. This has created uncertainty for project proponents and concern about future eligibility requirements and project returns. These political uncertainties are layered on top of those concerning international and domestic carbon markets and prices. Under the CE Act, the price of Australian carbon units is fixed for the first three years of the scheme ( to ). During this period (the fixed charge period ), liable entities are allowed to surrender Kyoto ACCUs but there is a cap of 5% on their use, which is designed to protect government revenues from the sale of carbon units. From 1 July 2015, the scheme becomes a standard cap-and-trade emissions trading scheme (the flexible charge stage ). In the first three years of this stage, there will be a price ceiling, starting at AU$20 above the expected international price (presumably the price of Certified Emission Reductions (CERs)) and rising by 7.5% per annum in the following two years. There will also be a 50% cap on the use of international units and 12.5% cap on the use of eligible Kyoto units (CERs, ERUs and RMUs) but no limits on the use of Kyoto ACCUs. The initial scheme included a floor price, however, it was abandoned in late 2012 and replaced with an undertaking to link the Australian carbon pricing scheme with the EU ETS. The design features of the carbon pricing scheme expose CFI proponents to the uncertainties associated with the EU ETS and international climate negotiations. Until 11

12 there is greater certainty about future carbon markets and prices, it is likely that proponents will be wary of undertaking CFI projects, particularly sequestration projects. Transaction costs As the likes of Cacho et al. and van Oosterzee have highlighted, the transaction costs associated with carbon offset projects can be significant and act as a major deterrent to project activities [7, 21]. Under the CFI, standard projects will typically incur costs associated with becoming a registered offset provider, obtaining project approval, preparing offset reports, auditing offset reports, obtaining a certificate of entitlement for ACCUs, and registering and transferring ACCUs. Depending on the project type, project proponents can also be required to prepare, submit and refine methodologies. For sequestration projects, the proponent must hold the applicable carbon sequestration right (i.e. the exclusive registered legal right to obtain the benefit of sequestration of carbon in the relevant carbon pools) and have the consent of all people with an interest in the land (e.g. those with a freehold or leasehold interest, native title holders, and any person or institution with a mortgage or charge over the property). In addition, projects will often be subject to other regulatory requirements, including in relation to financial services, planning, water and environmental issues, and can incur stamp duty and other taxes. By creating the project-type test inherent in the CFI s positive list, the Australian Government showed a degree of responsiveness to concerns about transaction costs. However, further reform may be necessary in this area as the transaction costs associated with many project types are still likely to be prohibitive. An obstacle to this process is the nature of the Australian federation and distribution of powers within the Commonwealth. Australia has three layers of government, federal, state/territory and local. Broadly, the states and territories, and local government, are responsible for most real property, land use planning, water and environmental issues, while the federal government is responsible for most taxation, corporate and financial regulation, and issues for which there is a sufficient nexus to international affairs. Making modifications to the regulatory and taxation regimes that affect the CFI is likely to be impeded by the need for cooperation amongst the different levels of government and government agencies. Integrity- and perverse impact-related restrictions As described above, the CFI has mechanisms to deal with all of the major integrity and perverse impact risks associated with offsets. While these risks are real and need to be managed, a vulnerability that stems from the existing mechanisms is that they could unnecessarily impede the uptake of projects. The most significant issues relate to the 100 year permanence rule, abatement measurement and additionality requirements. The 100 year rule The integrity mechanism that has attracted the most public attention is the 100 year rule. Farm lobby groups and other landholders have expressed concern about locking up land for this period of time because of the associated financial and cultural impacts (many farmers feel a sense of obligation to pass on their land to their children, 12

13 free of encumbrances) [6]. The Liberal-National Party Opposition has responded by undertaking to reduce the permanence requirement to 25 years if they win office, a proposal that has been attacked by the Labor Government and others [102, 103]. The 100 year rule appears to have its origins in the rule of thumb that the atmospheric lifetime of CO 2 (the time it takes for an increase in the atmospheric concentration of CO 2 caused by a pulse of emissions to be reduced to 37% of its initial amount) is approximately 100 years [6, 21, 33]. Using this, the 100 year rule has seemingly been applied on the grounds that, if most of the CO 2 associated with an emissions pulse is re-sequestered, on a net basis, after 100 years, any release from carbon stores after this time is of little consequence. As discussed, provided there is a cap on Australia s national emissions, any reversal of the removals or avoided emissions associated with a Kyoto CFI sequestration project will not affect environmental outcomes. The risk that the Australian Government actually manages through the 100 year rule for Kyoto offset projects is the threat to its future revenues. The atmospheric lifetime of CO 2 is irrelevant for these purposes because the future emissions that are recorded in the national accounts are not discounted to account for carbon cycle dynamics. By structuring the permanence rule around an arbitrary 100 period, not only does it deter potential project proponents, but it does not fully eliminate the risks to government. Moreover, there are more effective ways of managing the residual financial risk associated with sequestration projects without the need for reliance on a 100 year permanence period [21, 22, 27, 34]. This can be illustrated using a hypothetical reforestation project involving permanent environmental plantings on 10 ha in the Southern Tablelands in New South Wales that commences in Under the existing methodology for permanent environmental plantings, which uses the CFI Reforestation Modelling Tool [104], the only carbon pools that are accounted for are live above- and below-ground biomass and debris. 13 The estimated increase in the carbon stock in these pools over 100 years is 2,152 tco 2. After the deduction of the risk of reversal buffer (5%), and assuming no further deductions are made for leakage or other emissions associated with the project, the project proponent receives a total of 2,045 ACCUs, or an average of 20.4 yr -1. It is conservatively assumed for these purposes that the risk of reversal buffer accurately reflects temporary carbon losses from the project area due to natural disturbance events (e.g. fire and drought). The financial risk faced by the Australian Government is that, at the end of the permanence period, the entire project area may be deforested. Assume for current purposes that this occurs in 2113 and that there is an instantaneous release of all carbon stored in the carbon pools. Under this scenario, the financial exposure of the Government is represented by the net present value (NPV) of future lost carbon revenues. This was calculated using a 7% discount rate and three carbon price scenarios: 13 Carbon Farming (Quantifying Carbon Sequestration by Permanent Environmental Plantings of Native Species using the CFI Reforestation Modelling Tool) Methodology Determination 2012 (Cth). The methodology also requires deductions to be made for emissions from fuel use and CH 4 and N 2 O emissions from fire (biomass burning). These deductions are ignored for the purposes of the hypothetical case study. 13

14 the Clean Energy Future (CEF) price scenario, where the carbon price follows the statutory price until the end of the fixed price period ( ), tracks the Australian Treasury s CEF price path over the period to , and then increases at 4% yr -1 real to ; a low price scenario, where the carbon price follows the statutory price until the end of , falls to $10 (nominal) in and then grows at 2.5% real through to ; and a high price scenario, where the carbon price follows the statutory price until the end of , tracks the Australian Treasury s high price path through to , and then increases at 4% yr -1 real to (Fig.1) [35]. 14 Figure 1 Clean Energy Future, low and high carbon price scenarios, real 2013 $A/t CO 2 -e Data from Australian Treasury [35] and author estimates. As the results in Table 3 demonstrate, the 100 year permanence rule does not eliminate the financial risk to the Government. The NPV of the future foregone revenues ranges between AU$253 and AU$8683 (2013 A$), depending on the carbon price scenario. 14 The 4% real carbon price growth rate in the CEF and high price scenarios was based on the Hotelling rule [36]. The 2.5% real growth rate in the low price scenario was based on the assumption that the international community adopts less aggressive mitigation objectives than envisaged with the 2 C target. 14

15 Table 3 Residual risk to Government with existing 100 year rule, real 2013 A$ Price scenario Low CEF High Foregone revenues in ,272 3,727,065 7,534,235 NPV of foregone revenues 253 4,295 8,683 To eliminate the financial risk associated with the potential reversal of the sequestered carbon, an annual permanence deduction could be required on top of the 5% risk of reversal buffer. With a permanence deduction of 3% per annum, the NPV of future foregone revenues under the low price scenario is reduced to zero. Under the CEF and high price scenarios, the same result can be achieved with a permanence deduction of 13%. If the permanence period was reduced, the annual permanence deduction would have to be increased if there was a desire to eliminate the risk to the Government. Table 4 shows the permanence deduction necessary under the three price scenarios to ensure the NPV of future foregone revenues is zero with four permanence periods (25, 50, 75 and 100 years), and assuming a 7% discount rate. Table 4 Required permanence deduction to eliminate residual risk with different permanence periods Permanence period Annual permanence deduction (%)* Price scenario Low CEF High 25 years years years years * Assumes 7% discount rate. The hypothetical analysis contained in Tables 3 and 4 is based on particular assumptions about the carbon price, rate of removals, date of the reversal of the carbon stores and discount rate. Alternative assumptions produce significantly different results, as the scenarios used here illustrate. The central point is merely that a fixed 100 year rule is not necessary to manage the financial risks associated with the potential non-permanence of sequestration projects. Moving to a discount-based approach, whereby proponents would able to select different permanence periods and a permanence deduction would then calculated on the basis of the project characteristics and length of the period, could achieve the desired policy objective of protecting the Government s revenues from carbon reversals without the need to lock up land for 100 years. In doing so, it could reduce the concerns of landholders about the legacy effects of undertaking sequestration projects and thereby increase project initiation. Other similar insurance mechanisms could also be used for these purposes [21, 22, 27, 34]. Abatement measurement As discussed, the CFI Act contains several layers of integrity mechanisms that are designed to minimise permanence and leakage risks. These include the requirement of 15

16 conservatism in methodologies and that methodologies not be inconsistent with the National Inventory Report, the risk of reversal buffer, and the need for methodologies to provide for a deduction for greenhouse gases emitted from any source as a consequence of the project. Like the 100 year rule, for Kyoto offset projects, the purpose of these requirements is to shield the Australian Government from potential lost revenue stemming from measurement and leakage risks. In implementing these requirements, a balance must be struck between the desire to protect the financial interests of the Government and need to promote offset projects. Excessive conservatism in methodologies reduces the financial returns from projects, thereby undermining their capacity to compete with alternative land uses. While the scheme is in its early stages and teething problems are to be expected, there is evidence that conservatism and overly restrictive methodology requirements may be impeding the uptake of projects. Examples include the following. Underestimating sequestration in forest models. Preece et al. found that the model used to estimate carbon stock changes in reforestation projects (i.e. the National Carbon Accounting System (NCAS) and FullCAM, which sit behind the CFI Reforestation Modelling Tool) potentially underestimates aboveground biomass in certain vegetation types [37]. This reduces the LULUCF credits recorded in Australia s greenhouse accounts and, in turn, the ACCUs that proponents receive for reforestation projects. Size and nature of the risk of reversal buffer. Arguably, the 5% risk of reversal buffer is unnecessarily high and, if applied uniformly, will not reflect the risk profile of individual projects. The effect is that low risk projects subsidise those with higher risk. Greater guidance is required to demonstrate if and how the risk of reversal buffer might be adjusted to account for the characteristics of projects and proponents, the extent to which cyclical variations have been accounted for in methodologies, and the conservatism in the applicable methods. A more effective approach could involve merging the buffer with a permanence period-permanence deduction mechanism, under which a single deduction would be made on the basis of the characteristics of the project and proponent. Exclusion of carbon pools. Under the permanent environmental plantings methodology, the soil organic carbon pool is excluded, even though it is counted towards Australia s mitigation commitments for the purposes of reforestation and regrowth on deforested land units [38]. This is likely to benefit proponents in the initial years of a project as reforestation/afforestation typically results in soil carbon losses in the years immediately following planting or seeding. In the longer term, the exclusion of the soil carbon pool will usually lead to losses to the proponent, with corresponding gains to the Australian Government, as soil carbon levels recover, then exceed, the levels under the previous agricultural land use [38-44]. Leakage deduction. The intent of the requirement that a deduction be made for greenhouse gases emitted from any source is to ensure that the abatement accredited for a project via the issuance of ACCUs is net of any increases in emissions caused by the project. For instance, the permanent environmental plantings methodology requires that, in determining a project s net abatement number, the carbon stock change in the live biomass and debris pools must be calculated, after which a deduction is made for fuel use emissions (CO 2, CH 4 16

17 and N 2 O) from vehicles and machinery used in site preparation, planting, management and other project-related activities (including transportation between business locations and to the site), and for CH 4 and N 2 O emissions from prescribed burning and wildfires. Within a purely voluntary offset policy structure, these deductions are appropriate and necessary to ensure the integrity of credits. When applied within the compliance and carbon pricing structure embodied in the Clean Energy Future package, they can result in perverse outcomes. In some cases (e.g. emissions from non-transport use of liquid fuels and scope 2 emissions from electricity use), 15 the deduction will result in a double application of the carbon price once via the fuel tax system or CE Act and then again via the lost ACCUs. This is inefficient and inequitable. In others (e.g. off road use of transport fuels for agriculture and forestry), 16 the deduction imposes an effective carbon price on emissions that would not otherwise be subject to one. Landholders who carry on with past land use practices are exempt from a carbon price for emissions from these sources but those who undertake an offset project are subject to a price for the same emissions through lost credits. This would fit with the structure of the Clean Energy Future package if the direct emissions deduction was calculated using a baseline representing the emissions from these sources under businessas-usual (or reference case) conditions. However, none of the relevant methodologies calculates the deduction on this basis; 17 the emissions are simply subtracted from the LULUCF, waste or agriculture-related avoided emissions or enhanced removals. To satisfy the equimarginal principle and ensure consistency with the structure of the Clean Energy Future package, deductions should not be made for project-related emissions that are already subject to a carbon price and, where deductions are made for emissions that are exempt from a direct or equivalent carbon price, they should be calculated against the counterfactual reference case. The conservative approach that has been adopted toward the measurement of abatement and issuance of credits is reducing the financial benefits associated with CFI projects. If the CFI is to realise its full potential, these and other similar requirements should be revised to shift the balance more in the favour of proponents. Additionality requirements Under the CFI Act, the Minister has broad powers to make regulations and declarations changing the way many aspects of the scheme operate. These include powers to include and remove activities from the positive and negative lists, and to waive the second limb of the additionality test. The way these powers are exercised will profoundly influence the trajectory of the CFI. 15 Carbon Farming (Destruction of Methane Generated from Manure in Piggeries) Methodology Determination 2012 (Cth) and Carbon Farming (Capture and Combustion of Methane in Landfill Gas from Legacy Waste) Methodology Determination 2012 (Cth). 16 Carbon Farming (Quantifying Carbon Sequestration by Permanent Environmental Plantings of Native Species using the CFI Reforestation Modelling Tool) Methodology Determination 2012 (Cth). 17 Under the legacy waste methodology, a deduction is made for fuel and grid-delivered electricity used to operate the landfill gas extract system using a baseline-and-credit approach. However, these emission sources are subject to a carbon price. 17

18 A much commented on deficiency of the Kyoto Protocol s first commitment period rules was the treatment of forestry sources and sinks, particularly the CDM s restrictive treatment of reforestation/afforestation projects and exclusion of emissions from deforestation and forest degradation, and the adoption of net-net accounting with a cap for forest management in developed countries [20, 29, 45]. The same bias against the conservation of carbon stocks in forests has emerged in the CFI. Despite the CFI Act explicitly providing for native forest protection projections defined as projects to remove CO 2 from the atmosphere by sequestering carbon in trees in native forests and avoiding emissions attributable to the clearing or clear-felling of native forests 18 at the time of writing, the CFI positive list did not include avoided or delayed native forest harvesting (i.e. improved forest management) or avoided native forest conversion (i.e. deforestation of remnant forest) projects. The CFI Act also excludes projects involving the clearing of native forest or use of material obtained by clearing or harvesting a native forest. This prohibition excludes delayed native forest harvesting projects and prevents any forest management project (should they become eligible) from including part of a forest estate that remains available for harvest. In doing so, it is likely to increase the methodological difficulties associated with devising baselines for avoided native forest harvesting projects and magnify leakage risks (i.e. proponents could increase harvest pressures in parts of a native forest estate outside the CFI project boundaries). In addition, the legislation limits native forest protection projections to a single crediting period with a default length of 20 years, which differs from other project types where crediting periods can be renewed and have a default length of seven years. These rules appear to have been based on the abatement characteristics of avoided deforestation projects, where the avoided emissions are initially large but then follow an exponential decay function that approaches zero after ~20 years. Although well suited to avoided deforestation projects, it is inconsistent with the abatement profile of avoided and delayed native forest harvesting projects. These project types could be significantly disadvantaged by the single crediting period restriction, particularly if it is limited to 20 years. No public explanation has been provided for the current bias against native forest protection projects. The situation is made more inexplicable by the fact that avoided forest conversion and improved native forest management potentially offer a large and cost-effective source of abatement in Australia, and that the Australian Government has historically been a strong supporter of programs to reduce deforestation and forest degradation in developing countries [46-50, 105]. An additional obstruction for forest management abatement in Australia is the Kyoto Protocol s second commitment LULUCF rules. To address concerns about the potential for hot air (credits that do not represent additional abatement), forest management credits, and credits associated with forest management project activities undertaken through the joint implementation (JI) mechanism, are subject to a combined cap of 3.5% of total base year emissions excluding LULUCF [50]. For Australia, the 3.5% cap equates to a limit of 15.4 Mt CO 2 -e yr -1 over the commitment period. As detailed in Macintosh [50], Australia s forest management reference level for multiple use public native forests and Tasmania s private native forests was calculated using the mean harvest rate from the period , and roundwood removals from Since that time, the native forestry sector has undergone a major contraction. The harvest area in native forests (broadleaved and cypress, excluding 18 CFI Act, s 5. 18

19 Queensland) in was 39% below the mean [51-55]. Total native broadleaved roundwood removals were 32% below the mean and 29% below the 2008 levels [56] (Fig. 2). The causes of the decline since 2008 are largely unrelated to policy. The industry has been struck by a confluence of events, including shifting market preferences (away from native forests), increasing competition from plantations, a high Australian dollar and depressed international woodchip prices [50]. If these conditions persist, and harvest rates remain at 2011 levels, Australia will receive approximately MtCO 2 -e yr -1 of forest management credits, leaving MtCO 2 -e yr -1 of space under the 3.5% cap. 19 That is, Australia will almost fill its 3.5% cap from credits that are largely attributable to non-policy factors. The cap will then strip away the incentive for further policy-induced abatement in the sector and, in doing so, potentially increase the costs associated with achieving Australia s mitigation commitments. Within the CFI, the practical impact will be to prevent forest management projects from generating Kyoto ACCUs. Any credits from these projects will be non-kyoto ACCUs that can only be sold into voluntary markets. Figure 2 Harvest area in native forests (broadleaved and cypress, excluding Queensland) (ha) and native broadleaved roundwood removals (m 3 ), Data from Australian Bureau of Agricultural and Resource Economics and Sciences [56] and state forest agencies [51-55]. Australia s situation vividly illustrates the downsides of using blunt caps to guard against additionality concerns. To resolve this issue, either the cap could be removed 19 Calculated using Australia s methods and datasets, except for changes in the harvested wood products pool, where an alternative method based on the Australian Government s wood flow model and the IPCC first-order decay function with default half-lives of 2 years for paper, 25 years for wood panels and 35 years for sawn wood. See Macintosh [57] for details. 19