Fixing the abatement black hole

With an emissions reduction target looming large, Greg Hunt cannot afford widespread failure on abatement promises. Tightening the Direct Action auction could save him embarrassment down the line.

Yesterday I wrote about how the Direct Action abatement auction scheme faces a major challenge controlling for the risk that winning bidders subsequently don’t deliver the amount of abatement they promise on the timetable promised (How 'non-delivery' haunts Hunt, October 22). Because the Abbott government has only six years left to reach its emissions reduction target, it can’t really afford to have large swathes of contracted abatement supply fail to materialise a few years after they’ve been selected in an auction.

So what to do?

I’ve come up with three options (but no doubt others could be imagined) which I’ll run though below, but all have their pitfalls. Because of these pitfalls I’ve suggested a fourth alternative: that the government acquire abatement through not just an auction but also offer a standing purchase price of $8 per tonne of CO2 abatement to anyone, irrespective of whether they participated in the auction or not. 

Here are the four options in more detail:

1) Bidders are screened for capability before qualifying to bid in auction

Under such a regime, firms wanting to bid into the auction must first pass an assessment that evaluates their technical and financial capability to deliver abatement projects of a given type (for example, destruction of methane from landfills, or upgrading the energy efficiency of commercial buildings). 

The ACT government’s utility-scale solar project auction employed such a screening process, evaluating prospective bidders’ experience and wherewithal in delivering multi-megawatt scale solar power projects. 

The problem though is that the government isn’t just trying to support solar PV projects. It needs projects from across an extraordinary spectrum of industries and technologies. So a really rigorous screening process across all these areas could rapidly get beyond the government’s own capabilities.

That’s because assessing a firm’s abatement project capability is not necessarily a black and white judgement, and can be highly subjective. A firm may have never delivered an abatement project in, say, tree planting before, but they might be very experienced in horticulture. Should they be disqualified from bidding?

If you apply a really rigorous process then the risk is you’ll reduce the extent of competition between bidders and therefore abatement prices will be higher.

It also reduces the potential for innovation from left-field proponents. Sometimes it takes someone from outside a given industry who looks at things differently to come up with novel approaches that dramatically reduce costs. Many of these people’s novel solutions fail to work, but the one that succeeds can sometimes completely transform what’s possible. Such left-field proponents will have limited demonstrated experience and carry high risks of failure so would be screened out of bidding, without even getting an opportunity to prove themselves.

2. Require bidders to provide bonds

By requiring winning bidders to provide a large financial bond upfront that the government can access in the event the bidder fails to deliver, it deters firms from making overly optimistic bids which they’ll struggle to deliver.

The problem though is that this could rule out firms from bidding in the auction who might be very capable of delivering cheap abatement, but lack the size or financial strength to find the money upfront to provide a bond.

3. Require firms to make good on undelivered abatement

The government could insert a clause in contracts with winning bidders requiring them to acquire abatement from others to make up for any abatement shortfall under their own contracts. This would act to reduce the likelihood of excessively optimistic bidding, while also ensuring the government wasn’t left stranded by bidders’ poor performance. Such make-good provisions are standard practice under contract law but haven’t been a feature of government abatement programs.

But this faces some challenges of its own. With the government scrapping the carbon price and setting itself up as the sole buyer of abatement credits, it has destroyed the potential for a liquid market in carbon credits. 

What’s the problem then?

Say you happened to break a friend’s television that you borrowed – no drama, you can pick another one up within an hour and your friend will be no worse off. That’s because there are lots of people trading televisions every day of the week.

But with the abolition of the carbon price there is no actively traded market in large quantities of Australian abatement credits. Instead the government has an auction process which it monopolises and no one else is allowed to compete with it to bid for abatement under that auction. For make-good provisions to work, it requires people who have failed to win under the auction to invest hundreds of millions of dollars in abatement projects in the hope that the winning bidders will fail to deliver. This is a very big call, at least in the first few years until the failure rate becomes more evident.

4. Augment the auction with a standing offer for carbon abatement credits

Greg Hunt doesn’t have to acquire abatement solely through an auction process that tries to determine in advance of delivery who is entitled to supply the government with abatement. In addition to the auction the government could also set a standing offer price it was willing to pay outside of the auction process for abatement on delivery from anyone at anytime. Such a price would be set at a level that was such a bargain that the government would have no qualms buying in large quantities. Given the government’s budget for Direct Action and my understanding of abatement supply costs, I’d suggest $8 per tonne of CO2 would be about right. If the government can acquire very large amounts of genuine abatement at such a low price I’d be astounded. But it’s better than nothing.

This would allow the auction process to apply controls like the three listed above, while allowing for abatement to come from firms who may not otherwise have been able to participate in the auction process.

It should also help firms with making business plans and investments around their abatement projects knowing a strike price at which the government would be willing to buy very large quantities of abatement.

This is the second article in a two-part series. The first part, on broken industry promises to deliver abatement, is available here.