31 May 2012

 

Legal News & Analysis – Asia Pacific – Australia – Environment 

 

The Carbon Farming Initiative presents opportunities for businesses interested in generating, trading and acquiring carbon credits, particularly for use to meet liability under the carbon pricing mechanism. Despite its potential, however, the Carbon Farming Initiative also creates novel risks and considerations that businesses should be aware of, including risks relating to market and regulatory uncertainty, land access issues and obligations associated with carbon credits being financial products and personal property.

 

Introduction 

 

With the commencement date of the carbon pricing mechanism (the "CPM") fast approaching, many businesses are starting to think about the best way of sourcing carbon credits. During the first three years of the CPM, liable entities will be able to use credits generated under the Carbon Farming Initiative (the "CFI") to meet 5% of their CPM liability. From 1 July 2015, these credits, known as Australia carbon credit units ("ACCUs"), can be used to meet up to 100% of CPM liability. Given the long lead team associated with CFI projects, businesses will need to start planning early if they wish to make full use of ACCUs, particularly from 2015 onwards. Whilst the use of ACCUs may be an attractive carbon credit sourcing option, and may indeed be cheaper than sourcing units from elsewhere, the CFI does give rise to some novel risks and considerations. This article highlights some of those risks, including market and regulatory uncertainty, land access issues, and the risks associated with the designation of ACCUs as financial products and personal property.

 

Overview of the CFI

 

The CFI is a carbon offsets scheme which accredits emissions avoidance and sequestration projects in the land sector. It allows participants to be issued with ACCUs representing the abatement of greenhouse gas emissions achieved by their projects. One ACCU is equal to one tonne of CO2-e abatement. ACCUs issued in respect of the types of projects recognised under the Kyoto Protocol can be exchanged for international units (and traded in overseas markets), surrendered under the CPM, or used in the voluntary market.

 

Market risk

 

Both domestic and international carbon markets are continually evolving, so the price of emissions units on those markets is likely to be volatile and difficult to predict. This volatility is an important consideration for those interested in investing in CFI projects because the price of ACCUs is likely to reflect the price of carbon units in the fixed price period, and the price of international units in the flexible price period. If prices of other units are volatile, prices of ACCUs are likely to mirror that volatility, making long-term investment decisions difficult.

 

A number of potential developments within international carbon markets may, if they eventuate, affect the demand for ACCUs. For example, the first Kyoto Protocol commitment period expires at the end of this year, yet there is still considerable uncertainty around whether there will be a second Kyoto commitment period and, therefore, what the price of international units is likely to be in both the long and short terms. Further, if REDD+ (Reducing Emissions from Deforestation and Forest Degradation) becomes recognised under the Kyoto Protocol, there is the potential for large numbers of low cost, fully fungible units from carbon offsets projects in developing countries to enter the international market, thereby potentially significantly reducing the value of ACCUs.

 

At the domestic level, the political uncertainty in Australia adds further to the difficulty in making informed investment decisions. If the Clean Energy Act 2011 (Cth) is repealed under a Coalition Government, the loss of the domestic compliance market will likely decrease the demand for, and value of, ACCUs, leaving only the less lucrative voluntary market.

 

Regulatory risk

 

Gaps in regulation

 

Some aspects of the CFI are still being developed. For example, currently only four offset methodologies have been approved. While a number of others are under consideration, it is difficult to predict the timeframe for the approval process. In addition, several activities that are expected to be covered by the CFI (such as native forest protection projects) have not yet been included in the "positive list." Unless a project is on the "positive list" it cannot be declared an eligible offset project. This is likely to delay broader uptake of CFI projects and the supply of ACCUs.

 

ACCUs as financial products and personal property

 

ACCUs have been designated as "financial products" under the Corporations Act 2001 (Cth) and the Australian Securities and Investment Commission Act 2001 (Cth). The outcome of this is that any entity which carries on a business of (among other things) providing advice on, dealing in, or making a market for ACCUs may be required to obtain an Australian Financial Services Licence and comply with relevant financial services laws. The market manipulation and insider trading provisions of the Corporations Act 2001 (Cth) may also apply to entities that trade in ACCUs.

 

In addition, ACCUs are personal property for the purposes of the Property Securities Act 2009 (Cth) and any form of security interest in the ACCUs will therefore need to be registered in accordance with the requirements of that Act.

 

Eligibility criteria

 

In order for projects to be declared eligible under the CFI, a number of criteria must be satisfied. These include the requirement that the project comply with an applicable methodology determination, not be mandated by law, and be of a kind specified on the "positive list" in the regulations. Each of these criteria may give rise to its own set of issues. For example, in order to comply with the requirement that a project proponent obtain the consent of every "eligible interest holder" to carry out a sequestration project, the project proponent will need to identify every person with an eligible interest in the project area.

 

One of the key questions for both resources companies and project proponents is whether a tenement is an "eligible interest". The answer depends on the location of the project. In Victoria, for example, it is likely that a tenement constitutes an eligible interest and a project proponent would therefore need to obtain the consent of the tenement holder to carry out a CFI project on the land subject to that tenement. In WA and Queensland, however, a tenement does not constitute an eligible interest in land so consent of the tenement holder to CFI projects is not required, which is good for project proponents but creates a new land access risk for resources companies that hold tenements in those States.

 

Specific issues arise in relation to the other eligibility criteria and these should be fully investigated by prospective CFI participants.

 

Permanence obligations

 

Carbon stored as a result of sequestration projects under the CFI must be maintained for 100 years, or the ACCUs received for those projects must be relinquished. The Carbon Credits (Carbon Farming Initiative) Act 2011 (Cth) imposes a number of rules to ensure that ACCUs represent permanent abatement. As most permanence obligations run with the land, subsequent landowners will be required to comply with them, which may give rise to unforeseen costs. This could decrease the value of the property on which a CFI project has been undertaken.

 

A risk likely to become more important in the longer term, is the land access issue created by CFI projects that "lock up" land for up to 100 years. Resources companies wishing to access land on which a sequestration project is located would have to acquire and relinquish the number of ACCUs already issued in respect of that project, thus incurring additional land access costs. Land access difficulties may also arise in relation to native title land where the the native title holder is deemed to hold the applicable carbon sequestration right (the exclusive legal right to obtain the benefit of sequestration of carbon in the relevant pool on the land). These new interests will need to be factored into the negotiation process for land access arrangements.

 

Opportunities for business

 

Although the CFI presents a number of challenges, it also offers opportunities. Many businesses may already be undertaking voluntary activities to reduce their carbon footprint or to comply with an obligation in an environmental approval. The recently released exposure draft Carbon Credits (Carbon Farming Initiative) Regulation 2012 makes clear that entities can use the same offsets project to meet their obligations under a condition of a State environmental approval and the carbon pricing mechanism (thus ensuring that an entity does not pay twice for its emissions).

 

It is also possible for abatement to be credited from 1 July 2010 provided the project meets the other relevant eligibility criteria. Businesses should therefore investigate the extent to which activities undertaken from 1 July 2010 could be eligible under the CFI.

 

Businesses should also consider the extent to which the CFI provides additional support for a business case to establish environmental projects. Finally, if a business is considering carrying out a land sector-based project, it should ensure, to the extent possible, that the project is CFI-compliant and able to generate ACCUs.

 

Actions

 

  • In order to reduce risk and derive the greatest benefit from the CFI, businesses should:
  • understand the risks associated with the eligibility criteria and permanence obligations and how these can be managed (from either a project proponent or land access seeker perspective, depending on the nature of the business);
  • monitor the evolution of the CFI and domestic and international carbon markets and factor in long term market risk into off-take and other contractual arrangements;
  • look for opportunities to use the CFI in respect of both current and future activities, for example, by using it to add weight to a business case for green investment, or finding ways of accrediting existing activities.

 

 

For further information, please contact:

 

Jeff Lynn, Partner, Ashurst

jeff.lynn@ashurst.com

 

Kirsty Soute, Ashurst

kirsty.souter@ashurst.com

 

 

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