Direct Action might actually work!

Based on its Green Paper, the Federal Government’s Direct Action Emission Reduction Fund scheme seemed to be designed to fail. But it's possible that sense may be prevailing in relation to energy efficiency initiatives. 

Originally, the Green Paper set out two design features that would have knocked out the two biggest sources of abatement:

1. Projects to reduce emissions from changes to energy supply were effectively unviable because the government said it was only willing to contract for the purchase of abatement over a maximum of five years. Changes to energy supply usually involve very large upfront capital investments in equipment, with lifetimes stretching well beyond a decade. Only rewarding the first five years of abatement is insufficient to make such lower emission investments attractive.
   
2. Projects to reduce emissions from energy demand efficiency were unlikely to be attractive because the government said it’d only pay for abatement after it had been delivered, rather than as an upfront grant or rebate. The key problem holding back energy efficiency is that energy consumers tend to apply very short-term, simplified investment decision rules to save thinking effort and time. This can include selecting energy consuming equipment based on a comparison of purchase price with scant thought to operating costs, or requiring two-year or less payback requirements irrespective of the percentage return on investment. The extra revenue from abatement credits in years three and beyond count for nothing if many households and businesses only consider a two-year payback or even a zero-year payback.

Based on discussions with a variety of stakeholders it appears the government is not budging on the maximum of a five-year contract term, so flaw No.1 is still embedded in the scheme.

But on point two it is considering the possibility of allowing energy efficiency projects to create and forward-sell abatement credits up to four years in advance, following the model of the NSW Energy Savings Scheme.

To explain with an example how this might work, someone could replace low-efficiency fluorescent lighting with highly energy efficient LED globes in an office building. After the lighting had been in place for a year, the facility would be assessed to determine how much electricity consumption, and therefore carbon emissions, had declined from lighting. The owner would then be awarded abatement credits for that first year but also for four subsequent years. All of these could be sold to the government there and then, but with an agreement that money would have to be returned if the lights were removed (unlikely, anyway).

To account for the risk that some abatement in future years wouldn’t materialise (say because a proportion of the LED lights didn’t last as long as expected) the amount of abatement credited for future years would be discounted. So in year two you might get 90 per cent of the abatement that was recognised in year one, and 80 per cent in year three ... etc.  

This approach of allowing for forward crediting of abatement, often known as deeming, is a common feature across a range of Australian market-based emission reduction schemes that support energy efficiency. Providing credit upfront reflects recognition of a simple reality of human behaviour as detailed by economics Nobel Prize Winners Herbert Simon and Daniel Kahneman – most households and businesses are not capable of processing all available information. So given electricity and gas represents a minor expenditure item (3 per cent or less of most households’ and businesses’ expenditure) it receives low priority in terms of thinking time.  

If the government does not proceed with forward crediting then it’s likely that they’ll have great trouble making any dent in emissions prior to 2020. Energy efficiency initiatives in the residential and commercial building sector, such as lighting upgrades, have the advantage that they are often quite quick to implement and relatively low cost (below $20 of government support per tonne of CO2 abated could elicit significant supply). Given the government has just six years to meet its 2020 emission reduction target and a very tight budget, it really can’t afford to have a scheme that makes little difference to the attractiveness of energy efficiency investments.

However, there is naturally a risk involved in handing out abatement credits before the abatement has eventuated. To minimise circumstances of rewarding abatement that doesn’t eventuate the government needs to put in place a series of measures, including:

– Conservative approaches for estimating the likely future abatement from projects and products that mean abatement underestimates are more likely than overestimates; 

– A rigorous and well-resourced auditing program is required to check compliance and ensure installations are delivering the savings expected;

– The regulator needs to monitor the market for energy-consuming equipment closely, and quickly adjust the rules to respond to situations where a particular energy efficient product is no longer likely to be delivering meaningful abatement. For example, LED-LCD televisions used to be vastly more efficient than the market-dominant technology of plasma screens, but now they are the default technology. Also if appliances end up achieving really low levels of standby energy use, then the amount of abatement delivered by a power board which switches them off when inactive needs to be revised downwards. In previous energy efficiency incentive schemes, regulators have often been too slow to respond to developments in the market which meant that supported products were not delivering the energy savings that had been assumed.