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8 July, 2014

 

Legal News & Analysis – Asia Pacific – Australia – Environment 

 

Emissions Reduction Fund – proposed Carbon Abatement Contract released

 

What You Need To Know

 

  • On 27 June 2014, the Federal Government released the exposure draft Carbon Abatement Contract.
  • In accordance with the Federal Government’s proposed position under the Emissions Reduction Fund White Paper, the proposed Carbon Abatement Contract will be used by the Federal Government to purchase Kyoto Australian carbon credit units from successful bidders in the Emissions Reduction Fund auctions.

What You Need To Do

 

  • Interested parties should review the draft Carbon Abatement Contract and accompanying discussion paper, and if relevant, provide a submission to the Clean Energy Regulator by 18 July 2014. 

 

Following the release of the Emissions Reduction Fund White Paper (White Paper) and the exposure draft legislation for the Emissions Reduction Fund (ERF), the Federal Government (Government) has released the exposure draft Carbon Abatement Contract (Draft Contract) to form the basis of the ERF auctions. The full Draft Contract can be found here. The Draft Contract was released with an accompanying Carbon Abatement Contract Exposure Draft Discussion Paper (Discussion Paper), which sets out specific issues the Government are seeking comments on. The Discussion Paper can be found here.

 

Form Of The Draft Contract 


The Draft Contract is a simple vanilla sale and purchase agreement which sets out the standard terms and conditions which the Clean Energy Regulator (on behalf of the Commonwealth of Australia) will enter into with successful bidders at the ERF auctions. Under the Draft Contract, the Clean Energy Regulator (Buyer) agrees to pay for a nominated quantity (Contract Quantity) of Kyoto Australian carbon credit units (Units) at the price determined through auction, and the participant (Seller) must deliver these Units.
The Draft Contract is not a funding agreement or grant contract underwriting the Seller’s project as bid at the auction. In fact, the Draft Contract contains very few obligations in relation to the project, other than the Seller’s warranties in respect of the information provided at the ERF auction and the Seller’s assumption of all costs associated with the project. 


How The Draft Contract Works

 

Qualification Stage

 

  • Participants must meet qualification requirements – eligibility and credibility of emissions reductions from project. 
  • Participant to nominate delivery schedule.


Auction Process

 

  • Bid into auction and if successful, Draft Contract automatically commences or commences after execution (to be decided). 
  • Cannot negotiate terms once bid is successful.

Conditions Precedent

  • Seller to meet certain condition precedents within a set period, currently proposed to be 18 months (actual conditions and period to be decided), including demonstrating it has sufficient funding.

Draft Contract

 

  • Primary obligations in the Draft Contract take effect.

 

What The Draft Contract Covers 


Conditions Precedent – Project Milestone

The Draft Contract contemplates the inclusion of conditions precedent but does not give guidance as to what would be acceptable conditions. In other government schemes (such as the Low Emission Technology Development Fund or the Solar Flagships Program) this has been controversial as significant issues have arisen in relation to defining and achieving project milestones as conditions precedent. 


Although a project may be a registered eligible offsets project, a proponent will not have gone to the expense of ensuring the project can commence immediately so there will be additional project milestones to be achieved before Units can be credited in respect of a project. Unless the conditions precedent properly respond to the project milestones, then proponents could be bound to pay liquidated damages for a project that cannot get started.


Delivery Of Units (Or Make-Good Units) 


The Seller is to deliver the Contract Quantity in accordance with the delivery schedule nominated by the Seller in the qualification stage. Delivery occurs through the Australian National Registry of Emissions Units. 


The Seller can deliver either Units issued in respect of the Seller’s project bid at auction or Make-good Units. Make-good Units are those Units issued in respect of other projects, purchased through the secondary market. The Draft Contract allows the Seller to determine the amount of Make-good Units it delivers to fulfil delivery obligations. While the Discussion Paper notes that large deliveries of Make-good Units may cause the Clean Energy Regulator to question the accuracy of information provided during the qualification stage, it is difficult to see how this would give rise to a right to terminate unless the information provided at auction was intentionally false or misleading (and is therefore a breach of the Seller’s warranties). 


Failure To Deliver Units 


The Draft Contract does not contain a mechanism for the nominated delivery schedule to be varied. The Discussion Paper notes that the delivery schedule “could be varied with the parties’ mutual consent” however, this position reflects any commercial arrangement, in that parties are always free to agree amendments to existing contracts. 


Failure to deliver the agreed quantity of Units on the agreed date, constitutes a Delivery Failure. Where this occurs, the parties must use reasonable endeavours to agree a revised delivery schedule (without affecting the period of the Draft Contract). If such an agreement is not reached within 10 business days, the Seller must pay the Buyers liquidated damages (discussed below) unless the Seller elects to terminate the Draft Contract. 


Force Majeure 


Under the Draft Contract, force majeure is an event:

 

that is beyond the reasonable control of a party that renders performance of its obligations impossible,


explicitly excluding lack of funds and the inability to deliver units where Make-good Units are available. 


Obligations impacted by force majeure are suspended for the duration of the force majeure. If force majeure causes a Delivery Failure, parties must negotiate in good faith to agree a revised delivery schedule (as a general rule, without affecting the period of the Draft Contract). Where the Seller can show force majeure will prevent delivery of the Contract Quantity, the Contract Quantity may be reduced with the consent of the Buyer. The Draft Contract may be terminated by either party without damages if force majeure persists for 365 days.


The force majeure provisions seem to have minimal practical application as the force majeure event must prevent the performance of obligations under the Draft Contract. Given that the Seller’s primary obligation is to deliver Units (which can include Make-good Units), it is difficult to see how any event other than a failure of the registry would prevent the Seller from performing its obligations. 


The force majeure definition seems to be too narrow and does not respond to the effect of such events on the project. If, for example, a project is disturbed due to a natural disaster, the Seller suffers a loss from the project as well as costs in procuring Make-good Units. The Clean Energy Regulator’s position on project risks is that these risks are insurable and insurance costs are moderate compared to the cost of insuring against risks to the project more broadly. 


This is also relevant to the termination right for an extended force majeure. This is often a key mitigation measure for a supply obligation where there is a failure of a project due to external issues beyond the proponent’s control.

 

Liquidated Damages Regime 


Liquidated damages are payable by either party under the Draft Contract for termination or Delivery Failure. They are payable:

 

  • by the Seller, to represent the Buyer’s costs of replacing undelivered Units from the secondary market. The damages are calculated as the positive difference between the amount the Buyer would pay to purchase the quantity of defaulted Units on the market and the price payable for the purchase of those defaulted Units under the Draft Contract. This difference is capped at the price paid per unit under the Draft Contract multiplied by the quantity of defaulted Units. 
  • by the Buyer, to compensate the Seller for loss incurred as a result of selling Units for a price lower than it would have received under the Draft Contract. The damages are calculated as the positive difference between the price paid per Unit under the Draft Contract and the market price for the Units.

Confidentiality And Intellectual Property 


The confidentiality provisions in the Draft Contract are very narrow, restricting only the disclosure of the price agreed for each Unit. The restrictions do not extend to the information provided during the auction process or provided under the Draft Contract in respect of the project (the Clean Energy Regulator has very broad rights to request any information in respect of the Seller’s project). 


The Draft Contract is also silent on intellectual property. The process to bid in ERF auctions assumes that project specific information is provided and vetted at the qualification stage to ensure participants meet the ‘qualification requirement’ prior to bidding. This means that any intellectual property provided in respect of a project is not afforded any protections under the Draft Contract. Given many of the potential projects will involve the development of new intellectual property, this needs to be dealt with in this forum, the auction rules or the ERF legislation (and beyond protections included in freedom of information type legislation).


Overall Comments 


The Draft Contract is drafted with the principle that it is a contract for the supply of Units, much like a commodity contract, such as contracts for renewable energy certificates. It is based on a premise that there is an underlying liquid market so that Make-good Units can be acquired where the project cannot deliver the required Contract Quantity and that there is a high level of certainty of project success. 


As a result, it does not include provisions relating to, or providing relief from, Unit supply obligations as a result of project specific issues. This is particularly acute for projects based on new or untested technology or a new method applicable to offset projects.
There is a real question as to whether the Draft Contract should be more project-centric given the infancy of this market and the broad range of projects to which it can apply. 


What Next? 


If you are interested in providing a submission on the Draft Contract, you must do so by 18 July 2014 as submissions received after this date will only be considered at the Clean Energy Regulator’s discretion.

 

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For further information, please contact:

 

Tony Hill, Partner, Ashurst
[email protected] 

Jeff Lynn, Partner, Ashurst
[email protected]

 

Paul Newman, Partner, Ashurst 
[email protected] 

John Briggs, Partner, Ashurst
[email protected]

 

James Bruining, Partner, Ashurst 
[email protected]

 

Natsuko Ogawa, Partner, Ashurst 
[email protected]

 

Peter Limbers, Partner, Ashurst 
[email protected]

 

Teresa Scott, Ashurst
[email protected]

 

Ashurst Environment Practice Profile in Australia 

             

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