Direct Action mysteries remain

Greg Hunt delivered a speech last night at the Australian National University where he confirmed the Coalition will implement a baseline and credit mechanism employing a reverse auction for purchasing abatement. 

In addition he made a very clear commitment around timing for implementation, stating the scheme would commence operation by July 1, 2014. He has also made it known that the budget remains fixed at $300 million for the first year then $500 million and $750 million for the subsequent years. No detail was revealed on spending for the years after this.

This speech, following up on the statements he made at the Alliance to Save Energy conference in February (detailed here), now unambiguously confirm that the Coalition has abandoned the idea of employing grant tendering. This is a genuine advance as experience shows that grant tendering has been a dismal failure, and would have run the risk of becoming a National Party slush fund (as illustrated in the Coalition’s discussion paper for developing Northern Australia). 

Hunt’s speech to the ANU restates that the Coalition would build on the Carbon Farming Initiative component of the government’s carbon trading scheme, which uses pre-set cookie-cutter methods for determining eligible abatement activities and estimating and verifying the abatement these activities deliver. They will then expand the eligible activities to include such things as energy efficiency improvements. 

In many respects this would operate much like Australia’s first emissions trading scheme – the NSW Greenhouse Gas Abatement Scheme or Kyoto’s Clean Development Mechanism.

The one critical difference would be that demand for abatement credits would come solely from the government budget rather than the private sector trading amongst themselves to minimise the cost of compliance with a legal obligation.

Outstanding issues for the Coalition

Auction process suffers from abatement under-delivery risk

The use of this auctioning process with pre-set generic abatement activities is a major improvement over grant tendering but still suffers from the same risk of abatement under-delivery. 

While Hunt has said the scheme will not hand over cash to successful bidders until after they deliver abatement (big improvement over grants), it selects eligible abatement providers in advance via the auction. History indicates that successful bidders to these kinds of competitive programs underestimate the time and cost of their projects and overestimate the scale of abatement they can achieve. 

The Coalition could find that the auction goes off magnificently with lots of very low cost abatement offered up. But then three years later it finds itself with a massive shortfall in abatement that is physically delivered. At this point it will only have three years left to make up the shortfall necessary to meet its 2020 target – a very short period of time in the world of abatement project development.  

The Coalition needs to explain how it will contain such a serious risk to achievement of the 2020 target.

Emissions baselines regime can be rorted and gamed

There is still a major area of the policy that Hunt is yet to adequately explain, which is the application of emissions baselines and associated penalties to large emitting facilities such as oil refineries, steel mills and power stations.

So far what he has outlined could conceivably work for creation of carbon credits in new project initiatives such as: 

-- in the land sector, for example, through tree planting;

-- avoidance of vented methane from landfills and piggeries; and

-- smaller scale generic energy efficiency changes in residential and commercial sectors such as removal of old fridges or more efficient lighting.

These are all very useful. But the emission reduction fund must also deal with existing large emitting facilities that are each individually different and not amenable to cookie-cutter approaches.

The Coalition has already outlined in its 2010 Direct Action policy that it would apply emission baselines to existing emitters and if they exceeded their baselines they would face a penalty. At the same time they could offer to sell down their emissions baseline entitlement via the auction process. This could provide a good way to drive emission reductions from major emitters. Government wouldn’t need to get into the mechanics of the specific abatement projects these emitters might undertake, it just focuses on what their end emissions are.

But it is also riddled with incredible complexity and traps that could lead to rorts and risks around achieving the 2020 abatement target.

In an interview on Lateline last night, Greg Hunt was hesitant to go into detail about baseline setting and refused to provide any indication on the level of penalties that would apply for exceeding baselines. However he did say that baselines are likely to be set with a view to firm’s historical average emissions.

Here are some of the issues with such an approach that Hunt needs to explain how he’ll address:

Baseline unders and overs and the need for a strong penalty

Firms regularly experience variation in their output and emissions from year to year. Without a significant penalty for exceeding baselines, firms can game the Emission Reduction Fund. When their emissions fall below their baseline they get to earn money from the government but then the next year they might exceed their baseline and overall emissions are no lower in spite of this government handout. 

This is exactly what happened under the Renewable Energy Target where hydro generators have received Renewable Energy Certificates even though their overall generation has not increased from historical averages.

The Coalition’s scheme simply will not work without applying a strong penalty to discourage firms exceeding their baselines. Yet Hunt is saying he is assuming the scheme will not raise any revenue from application of penalties.

Double selling abatement from energy efficiency

Hunt has said his scheme will pay for abatement from energy efficiency initiatives. This will in many cases involve reductions in electricity consumption that will then directly reduce emissions from electricity generators such that some of them will emit below their historical average baseline. The scheme would need to prevent generators from being able to sell these resulting emission reductions into the auction, because it will mean paying twice for the same abatement.

Paying for abatement from business as usual production declines

Due to a range of underlying economic factors, a range of polluting facilities will experience declines in their production and therefore emissions below historical averages. We’ve already seen this with several aluminium smelters and oil refineries. These firms could then potentially sell the emission reductions below their baseline into the auction, even though these would have naturally occurred without the need for government money.

This poses a real problem because the budgeting for how much abatement the Coalition need to buy to reach its 2020 target is based on a Department of Climate Change business as usual projection which already takes into account some natural declines in economic output and emissions from some sectors. In essence there is some business as usual emission reductions that the Coalition would need to pay for, but has not budgeted for. 

These are not irresolvable issues. Yet they are just a sample of the some of the potential problems the Coalition must address for their 2020 emission reduction target commitment to be credible.