Australia will hold the first auction under it’s A$2.55 billion ($1.96 billion) Emissions Reduction Fund this week, a policy that most experts dismiss as inadequate. What is all the controversy about? We asked Grant Anderson, a partner and climate change policy expert with Melbourne-based law firm Allens, to explain.

The ERF is the main pillar of the Liberal party government’s Direct Action Plan to meet its target of cutting GHG emissions to 5% below 2000 levels by 2020, a target Environment Minister Greg Hunt says Australia will “easily meet” even though the government has not done any modeling to test whether the ERF will be effective.

As project developers ready their bids for the first auction, due this Wednesday and Thursday, observers say the ERF will do little to change Australia’s emissions trajectory, as illustrated by lax regulations in the proposed safeguard mechanism rules published last month.

CP: Who is allowed to bid in the auction, and what exactly are they bidding for?

GA: Proponents of carbon abatement projects undertaken in Australia in accordance with an approved methodology are able to bid the resultant emissions reductions into the Emissions Reduction Fund through a reverse auction process. These projects (called “eligible offsets projects”) must satisfy a number of criteria, including that they are additional (in the sense of not having commenced before they are registered with the Clean Energy Regulator, not required to be carried out under law and not supported by an Australian government programme) and that the project proponent is a fit and proper person.

Such bidders are bidding for the right to sell future emissions reductions from these eligible offsets projects, which are unitised as Australian carbon credit units, to the Clean Energy Regulator (on behalf of the Federal Government). Successful bidders are required to enter into a carbon abatement contract with the Clean Energy Regulator, which specify the amount of abatement to be sold, the price to be paid for that abatement and the delivery schedule.

CP: How will the Clean Energy Regulator decide which bids to accept and which to reject?

GA: The principal criteria to be applied in deciding which bids to accept and reject is that the carbon abatement should be purchased at the least cost. This principle is given effect to by conducting the auctions as reverse auctions under which the lowest prices bid are accepted up to the amount budgeted to be spent on the auction.

CP: Which control mechanisms are in place to ensure that the auction winners will deliver real, credible emission reductions?

GA: Under the carbon abatement contract, payment is only made on delivery of the contracted Australian carbon credit units. Because these have to be created in accordance with a government-approved methodology, and their creation needs to be verified through an offsets report and (in some cases) audited, there is a high level of confidence that the successful bidders will deliver real and credible emissions reductions.

CP: Which project types are expected to be successful in the first auction, and what are price expectations?

GA: There are a range of projects which are likely to bid into the first auction, including forestry biosequestration, savanna burning, livestock emissions avoidance, landfill emissions avoidance, and waste coal mine gas capture and destruction projects. Successful projects will be those that bid the lowest price, although the extent of participation in the auction will be one of the determinants of the cut-off price for successful bidders.

CP: Can you explain briefly what the ‘safeguard mechanism’ is and why it is considered necessary? What is all the criticism about?

GA: The Emissions Reduction Fund does not itself impose any cap on Australia’s emissions – it is simply designed as a “carrot” to encourage carbon abatement projects. The stated purpose of the safeguard mechanism is to prevent emissions reductions purchased through the Emissions Reduction Fund being displaced by significant increases in emissions elsewhere in the economy.

The safeguard mechanism will do this by setting an emissions baseline for large facilities (those which emit more than 100,000tCO2e per year), so that where those facilities exceed that baseline they will be required to take some remedial action, likely to be the purchase and surrender of sufficient Australian carbon credit units to cover those excess emissions.

The issue is that, at least for existing facilities, this baseline is set at a relatively high level (the highest annual emissions for the facility during the period from 2009/10 to 2013/14). Accordingly, these baselines are only likely to “bite” if the emissions from a facility increase substantially above business as usual. This in turn means that there is no “stick” to ensure that there are significant emissions reductions.

CP: Some observers say the ERF could be turned into a baseline-and-credit scheme by making some simple adjustments to the rules. Can you explain how that could be done, and do you consider it realistic that it would happen?

GA: It would be possible to turn the ERF into a baseline-and-credit scheme by ratcheting down the baselines over time to more stringent levels, which in turn would result in facilities having either to reduce their emissions or purchase carbon units to cover their above-baseline emissions. This would result in increased demand for carbon units, which would stimulate the development of a secondary market in them.

It would also mean that the ERF moves from being funded from the public purse (as is currently the case) to being funded by those businesses that emit above their baselines. In this way the ERF becomes more sustainable into the future; currently it has only been allocated funding up to 2020 and, if it has to continue to rely on government funding, there will inevitably be concerns about whether it is just a short term measure.

In the current political environment, it is difficult to see these adjustments being made. The important thing is to preserve the scope for these adjustments to be made in the future.

CP: Despite the government’s reassurances that it will easily meet its 2020 climate target, a number of independent reports have concluded that the ERF is not enough. Why is it so controversial?

GA: As explained above, the ERF (including with the safeguard mechanism) is not likely to result in a substantial reduction in Australia’s emissions. At worst there could be continued emissions on a business as usual basis from those facilities covered by the safeguard mechanism, and an increase in emissions from those sectors of the economy that are not covered by the safeguard mechanism (the safeguard mechanism will only cover a little more than half of Australia’s emissions).

In addition, whether the ERF has the potential to elicit substantial emissions reductions has yet to be proven, and this is why observers will be keenly watching the results of the first auction.

By Stian Reklev – stian@carbon-pulse.com