While the finer details of the government’s plan to introduce a fixed carbon price from July 2012 remain a mystery, the release of The Garnaut Review’s Sixth Update Paper last week offers some insight into what the future Australian market for carbon offsets may look like.
Professor Garnaut’s Sixth update provides multiple recommendations on how to best price carbon in the Australian economy. Whilst topics such as the linking of compensation to income tax cuts and pension increases are sure to generate the bulk of media and political interest, this update also contains important recommendations on how carbon offsets may interact with a fixed carbon price in Australia. Professor Garnaut advocates the inclusion of an offset program in the design of any carbon pricing mechanism in order to encourage abatement activity in multiple industry sectors - particularly those not covered by the carbon pricing scheme such as agriculture. He also advocates that in order to address concerns about budget neutrality and undermining the abatement effort in other sectors, caps need to be placed on the quantity of offsets able to be purchased by liable entities to meet their responsibilities.
Professor Garnaut recommends that liable entities be limited to meeting 4% of their total emissions responsibilities through the purchase of ‘regulatory’ offsets (those which are Kyoto compliant) in 2012. This percentage would increase at a rate of 0.75% per year through to 10% in 2020. Using a baseline of a total national emissions liability of 400 million tonnes of CO2e per annum (government revenue forecasts for the CPRS were based on a total emissions liability of approximately 440 million tonnes of CO2e), the approximate size of the Australian regulatory carbon offset market ranges from 16 million tonnes per year in 2012 to 40 million tonnes per year in 2020. It should be noted though that emissions are expected to decrease over time as the carbon price increases, and thus the national emissions liability baseline may shrink. As an indication of the potential financial value of this market, assuming a starting carbon price above $20 per tonne and based on an average regulatory offset price of $20 per tonne (regulatory offsets used in the European and New Zealand emissions trading schemes – CERs – were selling for approximately AUD$19 per tonne at the time of writing), this values the Australian regulatory carbon market at approximately $320 million in 2012/13.
The Sixth Update Paper also provides a recommendation that would create what could be referred to as an ‘artificial voluntary carbon market’ separate to the voluntary market that already exists within Australia. That is, Professor Garnaut recommends that there is a strong case for the regulatory authority administering the scheme to purchase a set quantity of offsets (herein referred to as ‘voluntary’ offsets for simplicity) from non-Kyoto compliant land sector abatement activities. The Sixth Update Paper suggests that the quantity of ‘voluntary’ offsets to be purchased by the regulatory authority each year be capped financially at 2% of total scheme revenue in 2012, increasing at a rate of 0.25% per year to 4% in 2020. Using an annual revenue figure of $11.5 billion (based CPRS-era modelling assuming a carbon price of $26 per tonne) this values the ‘voluntary’ carbon market in Australia at $230 million in 2012. Assuming an average ‘voluntary’ carbon offset price of $15 per tonne, this places its size at approximately 15.3 million tonnes in 2012 – almost equalling the size of the regulatory market. Professor Garnaut has flagged a Dutch tender as a potential mechanism for the regulatory authority to acquire these ‘voluntary’ offsets.
Development of the carbon offset market in Australia is highly unlikely to occur smoothly and instantaneously. Professor Garnaut himself notes that it is likely to be several years before the imposed limits of offset purchases are reached. This mainly stems from concerns about the potential to supply a large enough quantity of both regulatory and ‘voluntary’ domestic land-based offsets in the initial years of the scheme. Indeed, with the Carbon Farming Initiative - the policy mechanism through which these land sector carbon offsets will be generated - yet to be legislated, and offset activities such as reforestation having lag times of 3-5 years between establishment and realisation of offsets, this appears to be a reasonable concern.
Whether Professor Garnaut’s recommendations on the purchase of offsets by liable entities and the regulatory authority will be adopted by the government remains to be seen. Indeed, the placing of quotas on the quantity of offsets able to be purchased by liable entities was a highly contentious issue during the original Carbon Pollution Reduction Scheme negotiations. Whilst the CPRS Green Paper originally proposed setting a limit on the quantity of international carbon offsets able to be purchased by liable entities, extensive lobbying by industry resulted in this notion being dropped and no limit being included in the final design of the scheme. It is thus highly likely that industry will again lobby hard to ensure maximum flexibility in their ability to access carbon offsets, based on their (quite reasonable) assumption that these will be able to be purchased cheaper than the fixed carbon price.
This time however the landscape is different and no longer is an emissions trading scheme on the immediate table, with a fixed price instead being proposed and promises of extensive compensation and budget neutrality being made. It is these promises that will ultimately force the government to impose a limit on the purchase of offsets by liable entities. That is to say, allowing liable entities unlimited access to the use of carbon offsets threatens the revenue stream from a fixed carbon price that is needed in order to ensure that the budget bottom line balances and funds are available to fulfil the promises of compensation, particularly those made to lower income households in the form of tax cuts. Considering this, it is safe to say that we can expect some kind of limit on the quantity of offsets able to be purchased by liable entities.
One point not elaborated on by Professor Garnaut in the Sixth Update Paper is the role, if any, to be played by international carbon offsets. In his recommendations for carbon pricing in Australia, Professor Garnaut has almost exclusively referred to the role of regulatory and ‘voluntary’ offsets generated from domestic land sector abatement and sequestration activities under the proposed Carbon Farming Initiative. In contrast, access to lower cost international offsets is likely to be a point of strong lobbying by industry. Given the supply-demand balance of the CDM-based offset market, it is likely that international credits will be able to be purchased on the market at lower cost than any meaningful fixed Australian carbon price. Moreover, international offsets are plentiful and easy to acquire, meaning that if there are problems with the supply of CFI offsets from Australian land sector activities, international offsets provide an attractive alternative. The current landscape is different however to that when the CPRS was being negotiated in that a fixed carbon price within Australia will not be linked with the international carbon market as a cap and trade scheme would be. This leaves little case for the allowance of international offsets where the primary role of offsets in the Australian fixed price scheme is now to encourage domestic abatement in those sectors, such as agriculture, not covered by the carbon price. Put simply, and as alluded to by Professor Garnaut, it is perhaps desirable that the key role of offsets in Australia’s fixed carbon price will be to act as a ‘carrot’ to reward abatement in the domestic land sector whilst other sectors will be motivated by the proverbial ‘stick’ in the form of a carbon tax. If this scenario is realised, and the use of offsets predominantly limited to those generated in Australia, it represents positive news and an exciting opportunity for the Australian land sector and the yet to be fully realised Australian carbon offset market.
Andrew Wilson is a Carbon Markets Analyst at Carbon House; an innovative carbon advisory, projects and training firm based in Brisbane.
andrew.wilson@carbonhouse.com.au
www.carbonhouse.com.au
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