CARBON POLLUTION REDUCTION SCHEME BILL 2009 Explanatory Memorandum

Commonwealth of Australia Explanatory Memoranda

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CARBON POLLUTION REDUCTION SCHEME BILL 2009

2008-2009

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

HOUSE OF REPRESENTATIVES

Carbon Pollution Reduction Scheme Bill 2009

REGULATION IMPACT STATEMENT

(Circulated by the authority of the Minister for
Climate Change and Water, Senator the Honourable Penny Wong)

Table of contents

Regulation Impact Statement 1
1) Background 1
2) Medium Term Target Range and Indicative Short Term Trajectory 11
3) Coverage 41
4) Reporting and compliance 81
5) Linking the scheme to international markets 91
6) Auctioning of Carbon Pollution Permits 105
7) Setting scheme caps 121
8) Carbon market 133
9) Taxation issues 151
10) Transitional issues 165
11) Governance arrangements and implementation 175
Attachment A: Small Business Impact Statement 191
Attachment B: Attachment B: Compliance cost assessment 195
Attachment C: Existing measures 231
Wilkenfeld review 235

Regulation impact statement

1) Background

Throughout 2007, the Intergovernmental Panel on Climate Change
(IPCC) released three Working Group Reports and a Synthesis Report
as part of its Fourth Assessment Report, the latest of its six-
yearly major reviews and updates of the science of climate change.

The science of climate change presented in the IPCC's Fourth
Assessment Report in 2007 paints a clear picture: warming of the
climate system is unequivocal, as evident from a wide range of
measurements. Numerous other changes in climate have been observed
in wind patterns, precipitation, sea ice, ice sheets, and in
aspects of extreme weather. It is very likely that greenhouse gas
increases related to human activity have caused most of the rise in
global mean temperature since the mid-twentieth century.[1]

New data and scientific understanding, unavailable in time for last
year's IPCC report, are starting to paint an even more worrying
picture of climate change.

The Garnaut Review's Report of September 2008 suggests that
emissions are tracking at the upper bounds of the scenarios
modelled by the IPCC. Recent research suggests that the rate and
magnitude of climate change over the next century may be at the
high end of the range estimated by the IPCC. Global mean
temperature and sea-level rise are tracking at the upper end of the
range of projections.[2] There is also increasing concern about the
stability of the Greenland and West Antarctic ice sheets, with
implications for sea-level rise.[3]

If emissions continue to increase at the current rate, the
concentration or stock of greenhouse gases in the atmosphere will
be around 1000 parts per million (ppm) of carbon dioxide equivalent
(CO2-e) in the second half of the century compared to 384 ppm in
2005 and 280 ppm in pre-industrial times.[4] Such a concentration
is expected to have severe impacts on our environment (as discussed
in chapter 2).

An emissions trading scheme

In recognition of the challenges posed by climate change, the
Government has agreed to implement a 'cap and trade' emissions
trading scheme (the Carbon Pollution Reduction Scheme) in 2010.

An emissions trading scheme is a way of limiting greenhouse gas
emissions. By setting a limit on total emissions and allowing
businesses to buy and sell permits to emit carbon, the trading
scheme will put a price on carbon in a systematic way throughout
the economy.

It is important to note that the costs to the community arise not
from the Scheme itself but from the Government's prior commitment
to reduce national emissions. Regulatory approaches to reducing
emissions would impose higher costs on the community because they
would not make use of the incentives created by the market
mechanism to draw out all low-cost opportunities to reduce
emissions (see box 1.1). While a Carbon tax would put a direct
price on carbon, there are other considerations which make a
trading scheme the preferred approach (see box 1.2).

As well as driving actual emissions reductions, the introduction of
a carbon price provides a financial incentive for investment in low-
emissions technology research, development and commercialisation.
It will also create an incentive for consumers to reduce the use
consumption of carbon intensive products (as these become
relatively more expensive).

|Box 1.1: Market efficiency |
|Consider a stylised example in which there are 10 |
|entities, each emitting one tonne of emissions |
|before the introduction of an emissions trading |
|scheme. The different costs of abatement (that is, |
|the costs associated with reducing emissions) of |
|these entities, from highest to lowest ($10 to $1), |
|are illustrated below. |
|The Government implements an emissions trading |
|scheme with a cap that limits emissions to eight |
|units across the 10 entities. In this example, this |
|means that eight entities will be able to purchase |
|and surrender permits in order to emit and two |
|entities will be required to abate. |
|In the chart, the darker bars represent the eight |
|entities that will emit (and surrender permits) and |
|the lighter bars represent the two entities that |
|will abate. The objective of the emissions trading |
|scheme is to ensure that the two entities with the |
|lowest costs of abatement abate. |
|An efficient market An inefficient market |
| |
| |
| |
| |
|In an efficient market, the entities that abate are |
|those with the lowest costs of abatement. The eight |
|entities with the higher abatement costs will |
|purchase permits for surrender following emission; |
|the two firms with lower abatement costs will abate.|
| |
|In this situation, the unit price will be $2 (equal |
|to the marginal firm's cost of abatement). Those |
|firms with a cost of abatement that is less than or |
|equal to the price are better off or unaffected, |
|respectively, if they abate. Those entities with a |
|cost of abatement higher than the price are better |
|off paying for the unit so that they can emit. The |
|direct cost of abatement in the economy is the sum |
|of the two abating entities' costs; that is, $1 + $2|
|= $3. |
|The market is said to be inefficient if any of the |
|eight entities with higher cost of abatement are |
|forced to abate rather than purchase and surrender |
|permits. An inefficient market will mean that the |
|over-all cost of the same level of abatement will be|
|greater than where the market is efficient. |
|Research undertaken as part of the report of the |
|task group on emissions trading indicated that |
|'regulatory' approaches to addressing climate change|
|were less efficient and more expensive than market |
|based mechanisms. Analysis undertaken as part of the|
|report suggested that use of regulatory measures to |
|reduce costs were roughly twice as expensive as a |
|broad based emissions trading scheme.[5] |
|Box 1.2: Why not a tax |
|Both an emissions trading scheme and a carbon tax |
|are ways of putting a price on carbon. An emissions |
|trading scheme restricts the quantity of emissions |
|and allows the market to set the price of carbon |
|pollution permits-the carbon price. |
|A carbon tax increases the cost of emissions by a |
|set amount and allows the market to determine how |
|much abatement to undertake in response - that is, |
|whether it is more cost effective to pay the carbon |
|tax or to undertake abatement. |
|Where the Government has full information, a carbon |
|tax and an emissions trading scheme can deliver |
|similar economic and environmental outcomes. |
|However, it is rare that the necessary information |
|conditions can be met for a carbon tax and an |
|emissions trading scheme to be equivalent policy |
|instruments. |
|The key benefit of a tax over a trading scheme is |
|that it fixes the costs of compliance, at least in |
|the short term. In the longer term, the Government |
|is likely to amend the tax to in order to generate |
|an emissions outcome that meets Australia's |
|international obligations (or is consistent with the|
|chosen trajectory). The other benefit is that, in |
|the absence of international linking, a carbon tax |
|is easier to implement (with reduced transaction |
|costs). |
|The key benefit of an emissions trading scheme over |
|a tax is that it secures the environmental objective|
|by controlling the quantity of emissions directly. |
|Emissions trading may provide greater long-term |
|policy credibility as the community can see the |
|direct link between the policy instrument and the |
|environmental objective. |
|Australia's international commitments are likely to |
|continue to be defined as quantitative targets so |
|this approach allows international obligations to be|
|managed more effectively. |
|Emissions trading has emerged as the preferred |
|approach in many other developed countries. In part,|
|this is because domestic emissions trading schemes |
|can easily be linked, giving firms the capacity to |
|access least cost abatement opportunities |
|internationally. As this occurs, carbon prices will |
|equalise across countries, creating a global carbon |
|price, without the need for centralised decision |
|making. Carbon taxes could also be harmonised but |
|this would involve multi-party agreement and would |
|therefore be difficult to achieve in practice. |
|Emissions trading also allows for mechanisms to help|
|entities manage the uncertainty around future carbon|
|prices. For example, emissions trading allows for |
|derivative financial products to be developed. It is|
|difficult for a carbon tax approach to provide |
|similar means to manage uncertainty around future |
|carbon prices. |

This Regulation Impact Statement

As noted above, the Government has already committed to introducing
an emissions trading scheme. Out of a concern to begin addressing
the challenge of climate change as soon as possible, this decision
was taken shortly after the election of the Labor government. A
Regulation Impact Statement (RIS) could not be developed in time
for this decision. Recognising this, the Prime Minister decided
that exceptional circumstances existed and a RIS was not required.
A post-implementation review of this decision will be undertaken
after the implementation of the Carbon Pollution Reduction Scheme.

While a decision to introduce an emissions trading scheme has been
taken, the precise nature of the scheme and the rules and
regulations surrounding its operation have not been settled. This
RIS provides information to assist in taking these decisions.

This RIS looks at the choice of a medium term emissions trajectory.
While this is not the cap on emissions that will exist under the
scheme and compel affected industries to limit their emissions, it
will have a direct bearing on that cap. As such, this decision will
have a significant impact on the businesses and industries affected
by the scheme as well as Australia's contribution toward addressing
the climate change challenge.

The RIS also looks at the detailed design issues affecting the
scheme. It considers such issues as:

. Which industries should be included in the scheme

. The reporting, compliance and governance frameworks
surrounding the scheme

. How pollution permits should be allocated, banked and used

. Whether the Australian scheme should link with
international schemes

. What taxation arrangements will apply to the scheme

This RIS and the decisions it supports form one step on the road to
implementing the Carbon Pollution Reduction Scheme. The Government
has already released a green paper that detailed many of the issues
to be considered when designing and implementing an emissions
trading scheme. That green paper and the submissions made in
response to it have been used extensively in the preparation of
this RIS. Box 1.3 outlines the consultation undertaken in the
development of the design framework for the CPRS. A further round
of consultation will be undertaken on the details of the
legislation via the release of draft legislation in early 2009.

Following this round of decisions there are still a number of
important decisions to be taken. Throughout 2009 the detailed
regulations supporting the scheme will be developed. Early in 2010,
it is expected that the Government will decide on the precise
scheme caps applying under the scheme. At that time the Government
will also consider its approach toward the expansion of the scheme
to include other industries or sectors. Additional details on the
timetable for introducing the emissions trading scheme are included
in section 11.

|Box 1.3: Consultation |
|Consultation on the design of the CPRS in an |
|integral part of the development of legislation, |
|regulations and administrative decisions |
|underpinning the scheme. |
|Prior to the release of the Green Paper, the |
|Department of Climate Change convened a series of |
|roundtables involving peak industry, non-government |
|and land use organisations. These were complemented |
|by an extensive program of bilateral meetings held |
|to discuss specific issues. |
|The Green Paper was released in July 2008 as a |
|consultation document to air the Governments |
|preferred positions. Stakeholder comment was |
|requested on these preferred positions as well as a |
|range of other issues for which detailed preferred |
|positions had not yet been developed (a deadline for|
|submissions was set at 10 September 2008). Over |
|1,000 submissions were received in response to the |
|Green Paper. This included submissions from |
|individual businesses, business groups, community |
|groups, environmental organisations and individuals.|
|Following the release of the Green Paper the |
|Department undertook a series of public meetings to |
|raise awareness of the positions in the Green Paper |
|and to answer questions about the design and |
|development of the scheme. The Department also |
|undertook a number of bilateral meetings with |
|individual business, business groups and other |
|interested stakeholders. |
|In addition to the release of the Green Paper, the |
|Department also released more detailed discussion |
|papers to elicit additional feedback on particular |
|aspects of the scheme. This included papers |
|discussing the coverage of synthetic gases (August |
|2008), the waste sector (August 2008) and forestry |
|(September 2008[6]). |
|The Government has also consulted with the states |
|and territories through a working group of the |
|Council of Australian Governments. |
|A 'white paper' detailing the Governments policy |
|positions will be released following decisions on |
|design of the CPRS. Consultation with interested |
|stakeholders on the design of regulations and the |
|implementation of the Governments policies will be |
|ongoing. |

Objectives

There are many choices involved in the design of an emissions
trading scheme. In making these choices, the Government is guided
by certain objectives.

The objective of the Carbon Pollution Reduction Scheme is to:

. meet Australia's emissions reduction targets in the most
flexible and cost-effective way

. support an effective global response to climate change and

. provide for transitional assistance for the most affected
households and firms.

In recognition of the need to address climate change the Government
has committed to the adoption of an emissions trading scheme. The
first part of the objectives recognises that it is desirable for
this scheme to be designed and implemented in the most cost-
effective way. That is, in considering options for designing the
scheme, the objective is to ensure that choices made reflect the
balance of costs and benefits that most benefits the community. In
many cases, this equates to minimising compliance and
administration costs. However in some cases, options with more
substantial compliance costs may be adopted as these options have
much greater benefits for industry, Government or the community in
general.

The second part of the objective recognises that, acting alone,
Australia cannot solve the climate change problem. Like other
nations, Australia must rely on international cooperation to
achieve the necessary reductions in global greenhouse gas
emissions. Therefore, it is vital that Australia's mitigation
efforts, including the Carbon Pollution Reduction Scheme, are
designed to support an effective global response.

A well-designed and successfully implemented Carbon Pollution
Reduction Scheme can contribute to shaping an effective global
response by:

. helping Australia meet its international climate change
obligations, including its national target under the Kyoto
Protocol[7]

. demonstrating to other countries that emissions reduction
targets can be achieved cost effectively though an
emissions trading scheme with broad coverage

. supporting Australia's international negotiating position

. helping to support the development of international
emissions trading.

The final part of the objectives recognises that the introduction
of an emissions trading scheme is likely to have a disproportionate
impact on certain households and industries. To assist in the
smooth introduction of the scheme assistance to some affected
industries and households may be necessary. In many cases, such
assistance is likely to be justified on equity and fairness grounds
rather than strict efficiency criteria.

2) Medium Term Target Range and Indicative Short Term Trajectory

Assessing the problem

Australia's economy and environment are likely to be
disproportionately affected by climate change. As Australia
generates only 1.5 per cent of global greenhouse gas emissions, its
actions alone cannot avert the worst consequences of climate
change: the only solution to the climate change problem is a global
one.

A comprehensive global solution is required to slow and ultimately
reduce global greenhouse gas emissions to avert dangerous climate
change. In determining Australia's role, domestic and international
actions are both important.

As part of developing these roles, the Government committed to a
long term goal of reducing Australia's greenhouse gas emissions to
60 per cent below 2000 levels by 2050, and to use a market-based
mechanism - the Carbon Pollution Reduction Scheme (CPRS) - as the
primary tool to achieve the emission reductions.

A key issue or problem to resolve in implementing the CPRS is to
define the parameters of the emissions constraint in the short to
medium term, as a pathway towards the long term goal of 60 per cent
emissions reductions below 2000 levels by 2050.

The national emissions trajectory is the rate and timing of
emissions reductions to achieve that target. Setting a 2020
national emissions target range (the 'medium term target range')
and an indicative short-term trajectory would serve two important
functions: signalling to the world the efforts that Australia is
making to reduce emissions (including compliance with existing
international obligations), and allowing all Australian businesses
and households to develop strategies to manage their energy use and
efficiently reduce their emissions.

This is particularly important to businesses that are major energy
users or direct emitters who will have a liability under the Carbon
Pollution Reduction Scheme (the scheme). In deciding on the shape
of the national emissions trajectory, it is important to take into
account not only the medium and long term goals, but also to signal
a likely path towards them.

In the Green Paper, the Government sought feedback on how the
trajectory and target range should be defined and communicated. In
parallel, the Australian Treasury and others analysed the economic
impacts of various national and international emissions reductions
scenarios for the Government and for the Garnaut Climate Change
Review. The results of these analyses, which were published in The
Garnaut Climate Change Review: Final Report (September 2008) and
Australia's Low Pollution Future: The economics of climate change
mitigation (October 2008), are relevant to decisions on the level
of the target range and the national emissions trajectory.

Objectives of government action

The purpose or objective of the 2020 target range and indicative
trajectory is to provide guidance to businesses and households
about future emissions reductions, as one of a number of factors
influencing planning and investment decisions that are sensitive to
future energy and carbon costs. In particular, the medium term
target range and trajectory will have a strong influence on the
scheme cap which will determine the number of permits issued for
the scheme up to 2020.

Setting a target range and indicative trajectory will also support
the Government's other key objective of contributing to a
comprehensive global solution that slows and ultimately reduces
global greenhouse gas emissions. In this context as a first step,
supplementing the Government's commitment to reduce emissions by 60
per cent of 2000 levels by 2050 with a 2020 target and indicative
trajectory, along with the introduction of the Carbon Pollution
Reduction Scheme, could allow the Government to signal credible and
robust steps to cut domestic emissions.

Alongside these high-level objectives, the Government outlined
additional criteria and objectives in the green paper that have
been tailored below as they can usefully inform the setting of
targets and trajectories, including:

. Environmental integrity. The target range and trajectory
together should catalyse a policy response that delivers
genuine reductions in global emissions and drive the
transformation of the Australian economy to a low-carbon
future. The environmental integrity of a target is
described by the actual emissions reductions it achieves.
A very ambitious target or a steep trajectory holds out
the prospect of greater environmental benefits, but if
they are too ambitious or too steep there is a risk that
society will decide that sacrifices to reach the target
are not worth making. An overambitious target that is not
achieved has less environmental integrity (and
effectiveness) than a realistic target that can be
achieved and built upon in future years.

. Economic efficiency. Achieving emissions reductions at the
lowest long-term cost maximises our ability to respond to
climate change. It is important to achieve our
environmental goals as efficiently as possible and get the
maximum value out of our mitigation efforts. To do
otherwise would waste resources and reduce our ability to
respond in the future. See Box 2.1 below for a discussion
of economic efficiency in the context of emissions
reduction policy.

. Flexibility. There are inherent uncertainties in climate
change science and in the global social and political
response to climate change. Policy must be able to respond
to changing circumstances in a way that is timely and
appropriate. Therefore, policy settings need to provide
both medium-term flexibility and clarity for decision
making in the short term.

. International objectives. Consistent with the over-riding
objective outlined above in relation to credible
Australian action, targets and trajectories should support
Australia's international negotiating objectives and be
consistent with international obligations, including trade
and climate change treaties. The target range is a central
means by which Australia signals the efforts we are
prepared to make as part of global endeavours to reduce
the impacts of climate change.

. Accountability and transparency. Business will make
investment decisions and householders will make lifestyle
choices based on the target range and the trajectory.
Decisions on targets and trajectories should be well based
and subject to public scrutiny.

. Fairness. Acting on climate change will impose costs as
the economy transforms, but the costs should be spread as
equitably as possible across the economy, and no one
should shoulder more than their fair share of them.

|Box 2.1: How economic efficiency applies to reducing|
|emissions |
|In general terms, economic efficiency is realised |
|when nothing more can be achieved using the |
|resources available. A system can be considered |
|economically efficient if it produces goods or |
|services at the lowest possible per-unit cost, or if|
|no one can be made better off without making someone|
|else worse off, or if output cannot be increased |
|unless inputs are also increased. |
|Economic efficiency will be enhanced when policy |
|settings encourage flexibility and focus efforts to |
|reduce emissions on least-cost options. This is a |
|central reason for adopting market-based approaches,|
|such as emissions trading. |
|The key efficiency issues in setting the trajectory |
|and the medium-term target range are achieving |
|efficient risk management and managing the pace of |
|economic adjustment. Where risk and uncertainty are |
|significant, as is the case in responding to climate|
|change, efficiency will be best achieved when risks |
|are assigned to those who are best placed to judge, |
|act on and manage those risks. |
|Governments and the private sector have different |
|strengths in judging and managing the risks or |
|likelihoods of different climate change impacts. |
|Neither has a clear advantage in assessing likely |
|future global emissions reductions. National |
|governments control whether they sign future |
|international agreements and take on specific |
|obligations. Businesses have less control over |
|emissions targets or carbon prices, but have many |
|options for managing uncertainty (ranging from |
|reducing emissions and energy use in their |
|operations to using financial instruments) and can |
|choose the best options to fit their circumstances. |
|Given these different strengths, and the inherent |
|uncertainties associated with climate change, it |
|would not be efficient to allocate all risk either |
|to government or to the private sector. Shifting the|
|full burden of risk management to government would |
|weaken commercial incentives to reduce emissions, |
|would reduce economy-wide efficiency, and could |
|reduce the environmental integrity of the Carbon |
|Pollution Reduction Scheme. |
|Government should be clear about its policy intent |
|and the processes involved in determining emissions |
|reductions over time. It is appropriate for the |
|Australian Government to put boundaries around the |
|scope and pace of economic adjustment over the next |
|10 to 15 years. |

Options and impact analysis

As noted above, the purpose of the 2020 target range and indicative
trajectory is to provide guidance to businesses and households
about future emissions reductions, as one of a number of factors
influencing planning and investment decisions that are sensitive to
future energy and carbon costs.

However, announcing and adhering to a single number for Australia's
2020 target would lock in the extent of our contribution before key
aspects of an agreement are settled, including its overall ambition
and the nature of other countries' commitments. To do so would also
transfer financial risk from emitters and energy users to the
Government and taxpayers.

The Garnaut Final Report suggested that different targets could
form the basis for emissions reductions pathways linked to
international action. Under that approach, Australia could proceed
along one pathway towards a less ambitious target until the
criteria for a second pathway to a more ambitious target were met,
at which time Australia could switch pathways.

A potential difficulty with that approach is that uncertainty about
the scope and parameters of future international agreements makes
it difficult to pre-specify precise pathways and mechanistic
switching rules. The international situation is likely to contain
ambiguities, which would result in a track switching decision
involving significant judgment and discretion, risking apparently
arbitrary outcomes for those affected. Furthermore, as the pathways
diverge, a switch may cause a large shock to the economy, even with
a period of notice.

Thus while at first it may appear that clarity would be provided to
business and the community through setting a specific target, the
likely need to switch pathways as international developments emerge
could be challenging to manage and could lead to some level of
dislocation in the economy if the path switching was relatively
rapid. To mitigate this issue, a significant period of notice
would be required, which itself would limit the flexibility
available to Government.

Expressing the 2020 target as a defined range allows for the
significant uncertainties about international arrangements beyond
the first Kyoto commitment period, giving the Government
flexibility to respond to changing circumstances and science while
limiting the range of potential outcomes for business. The higher
boundary of the range could represent Australia's minimum
commitment to emissions reductions, even in the absence of
international agreement for the period beyond 2012.

The lower boundary could represent the extent to which Australia
will accept tighter targets in the context of a comprehensive
global agreement under which all major economies commit to
substantially restrain emissions to achieve an ambitious
stabilisation goal, and advanced economies take on reductions
comparable to Australia's. However the boundaries would not
represent the distinct tracks (suggested by the Garnaut Review).

These high-level options, including the impacts that may flow from
defining particular emissions ranges can only be properly
considered in the context of modelling analysis and the
international negotiating environment.

Before considering the impacts of various emissions reduction
pathways, it is important to provide contextual background on
current and projected emissions.

Current and projected emissions

An important factor in setting the medium-term target range and the
trajectory is the projected level of emissions in the absence of
any policy action. Australia's greenhouse gas emissions are
published each year in the National Greenhouse Gas Inventory
(NGGI); and in February 2008, the Department of Climate Change also
published Tracking to the Kyoto target 2007: Australia's greenhouse
emissions trends 1990 to 2008-2012 and 2020.

Projections in Tracking to the Kyoto target used a combination of
'top down' and 'bottom up' models. For key sectors, such as
stationary energy, the projections used a multiple-model approach,
in which the sectoral projection is taken as the average of three
independent projections made using different sector models. The
overall projection for Australia was produced from the sum of the
individual sectoral projections. Chart 2.1 shows an estimate of
Australia's future emissions under current policy settings such as
existing measures including the 20 per cent renewable energy target
(see footnote in figure 2.1 and Attachment C).

Figure 2.1: 'Business as usual' and 'with measures' emissions
estimates

[pic]
Source: Department of Climate Change, Tracking to the Kyoto target
2007: Australia's greenhouse emissions trends 1990 to 2008-2012 and
2020, 2008'. 'With measures' includes a range of existing and
recently announced mitigation measures implemented across all
Governments, such as the new Australian Government measure, the
20 per cent Renewable Energy Target (Attachment C lists a range of
these measures).

Table 2.1 shows Australia's National Greenhouse Gas Inventory for
2005-06 and preliminary estimates of the likely inventory in 2006-
07 and 2007-08.

Table 2.2 shows Australia's likely emissions position in 2007-08,
based on the estimated national inventory.

Table 2.1: National Greenhouse Gas Inventory, 2005-06 (actual) to
2007-08 (estimate)

|National greenhouse|2005-06a |2006-07b |2007-08b |
|gas inventory | | | |
|(megatonnes) | | | |
|Energy-combustion |366 |372 |377 |
|of fuels | | | |
|Energy-fugitive |34 |35 |36 |
|emissions | | | |
|Industrial |28 |30 |31 |
|processes | | | |
|Waste |17 |17 |17 |
|Agriculture |90 |86 |88 |
|National inventory |536 |540 |550 |
|totalc | | | |

(a) Department of Climate Change, National Greenhouse Gas Inventory
2006, Commonwealth of Australia, 2008.
(b) Preliminary estimates.
(c) National Inventory excluding land use, land use change and
forestry. Net emissions from the land use, land use change and
forestry sector were estimated to be 40 Mt in 2006.

Table 2.2: Likely net emissions position, 2007-08

|Item (megatonnes) | |2007-08a|
|National inventory totalb |(1) |550 |
|National assigned amount under | | |
|the Kyoto Protocol: | | |
|Assigned amount per yearc |(2) |592 |
|Projected adjustments to | | |
|assigned amount: | | |
|Article 3.3: Deforestation, | |-23 |
|afforestation and | | |
|reafforestationd | | |
|Articles 6, 12,17: Flexibility | |n/a |
|mechanisms | | |
|Total projected adjustments |(3) |-23 |
|Net assigned amount |(4) = (2|569 |
| |) + (3) | |
|Net balance | = (4) -|+19 |
| |(1) | |

(a) Preliminary estimates.
(b) National Inventory excluding land use, land use change and
forestry. Net emissions from the land use, land use change and
forestry sector were estimated to be 40 Mt in 2006.
(c) Australia's Initial Report under the Kyoto Protocol,
revised submission 2008.
(d) As projected for the average of each year in the first
commitment period in 'Tracking to Kyoto 2008'-this projection is
subject to significant uncertainty.

Since 1995 emissions have been increasing at a trend rate of around
1 per cent a year, although there is significant annual variability
- emissions can vary by up to 5 per cent each year.[8] Many factors
drive this variability, including changes in economic activity,
population and commodity prices; the characteristics of coal, oil
and gas being extracted; and natural climate variability.

For example, emissions change during drought mainly because there
are fewer cattle and sheep, but also because there is less water
available for hydro-electricity generators, which increases
emissions from fossil-fuelled stationary energy generation.

On the other hand, if water shortages result in less cooling in
some coal-fired power plants, this can lower emissions. Variation
in emissions from land-use change is also affected by the area of
land cleared each year and the prevailing weather conditions (for
example, whether it was a drought year or a wet year).

Having ratified the Kyoto Protocol, Australia is committed to
restraining its national emissions to an average of 108 per cent of
1990 levels across the first commitment period (2008 to 2012). In
the event of a post-2012 international agreement, the specification
of a target range and the trajectory must take into account, both
likely emissions variability and our international obligations,
including any association with a post 2020 international agreement.

The medium-term target range can be achieved through a range of
measures, but primarily by the Carbon Pollution Reduction Scheme,
which will set caps on emissions from covered sectors of the
economy. Scheme caps will be set in line with the trajectory, but
there will always be a gap between the trajectory and the scheme
caps. Not all sectors of the economy will be covered by the scheme
in its early years, and not all entities in covered sectors will
emit more than the threshold amount for participation, so national
emissions will generally be larger than the scheme cap in any given
year.

Parameters used in describing the trajectory and target range

Both the trajectory and the target range can be described using
three related parameters:

. Tonnes of carbon dioxide equivalent (t CO2-e). This is the
internationally accepted measure for greenhouse gas
emissions. It describes, for a given mixture and amount of
greenhouse gases, the amount of CO2 that would have the
same global warming potential when measured over a
specified timescale (generally 100 years).

. As a percentage relative to a previous year. Australia's
Kyoto target, for example, is expressed as 108 per cent of
1990 levels, while the Government's long-term target is
expressed as a 60 per cent reduction below 2000 levels.
Because Australia's emissions in 1990 were almost the same
as in 2000 (547.7 million tonnes[9] and 552.8 million
tonnes[10] respectively), percentage reductions below 1990
and 2000 levels for Australian emissions are reasonably
similar.

. As a per capita percentage relative to a previous year.
This can sometimes provide a more meaningful comparison of
emissions reductions relative to other countries, because
it incorporates not only the absolute economy-wide change
in emissions over a timeframe, but also the change in
population. Per capita reduction targets below 1990 and
2000 levels are quite different, despite similar absolute
levels of emissions in those two years, because of
different populations in those years. Australia's per
capita emissions were 32.1 tonnes per person in 1990 and
28.9 tonnes per person in 2000[11].

Goals for greenhouse gas emissions reductions are sometimes
described in terms of a desired global outcome; for example,
'stabilising emissions at 500 ppm CO2-e', 'limiting global
temperature rise to 2 degrees Celsius' or 'avoiding dangerous
climate change'. Such goals are only meaningful at a global level.
The global atmospheric concentration of greenhouse gases and
resulting temperatures will only be stabilised by global efforts to
reduce emissions, which are the sum of national efforts. In
practice, there is no direct link between one country's emissions
reduction target in 2020 and global stabilisation at a certain long-
run concentration, because stabilisation results from the aggregate
of all countries' efforts over time.

Modelling mitigation

To inform the choice of a 2020 target range, it is useful to draw
upon the economic modelling of various policy scenarios. The
Australian Treasury modelled four scenarios, both for the
Government (published as Australia's Low Pollution Future and
referred to as the 'CPRS scenarios') and for the Garnaut Climate
Change Review (published in the Garnaut Final Report). The Garnaut
Climate Change Review also carried out separate modelling exercises
of two additional scenarios, which were also published in its final
report.

Both the Garnaut Final Report and Australia's Low Pollution Future
presented results from a combination of three top-down, computable
general equilibrium (CGE) models: the Global Trade and Environment
Model (GTEM), the G Cubed model, and the Monash Multi Regional
Forecasting (MMRF) model. GTEM and G Cubed are models of the global
economy, whereas MMRF is a model of the Australian economy with
state and territory level detail. The CGE models covered four key
policy areas:

. Global: rates and patterns of economic growth, technology
development and emissions

. National: overall performance of the macro-economy and
patterns of growth across industries, sectors, states and
territories

. Sectoral: likely technological development and timing and
scale of opportunities to reduce energy use and emissions

. Household: impacts on income, consumption, prices and
employment.

The CGE models were complemented by a series of bottom up sector
specific models for electricity generation, transport, land use
change and forestry.

The Garnaut Climate Change Review worked closely with the Treasury
to define the reference case (that is, 'business as usual' with no
new policies to reduce emissions and assuming no impacts from
climate change ). In the scenarios developed for the review, GTEM
outcomes were used as an input into the MMRF model, which was
augmented by bottom-up sectoral models. GTEM was extended using
GIAM (Global Integrated Assessment Model) to model the interaction
between the climate system and the economy in estimating global
mitigation and climate change damages.

Results from the modelling are described in terms of forgone growth
in gross national product (GNP); that is, GNP being a certain
percentage less than it is projected to be in the reference case.
GNP includes international trade and capital flows and, in a world
with internationally linked emissions trading, captures the impact
of importing and exporting emissions units.

Different assumptions, different results

Care is needed when comparing modelling outcomes from different
exercises. The extent to which modelling results can be compared
depends on how similar the models' methodologies and underlying
assumptions are. It is also important to emphasise that, while
economic analysis of emissions scenarios published during 2008
contains information about the likely increase in emissions, it is
not an emissions projection tool.

It is also important to bear in mind the different purposes and
emphases of different scenarios. The modelling results for the
scenarios presented in the Garnaut Final Report and Australia's low
pollution future use consistent models but contain varying policy
assumptions. In addition, these scenarios (see next section),
provide decision makers with some information about the sensitivity
of the modelling results to changes in the key underlying
assumptions to help inform choices about the carbon constraint, and
key scheme design features[12]. The major differences in
assumptions include the following:

. Modelled avoided costs of climate change. The Garnaut
Review identified four types of climate change induced
costs

- Type 1: economic costs of 'most likely' climate impacts
that are able to be quantified

- Type 2: economic costs that cannot be estimated with
confidence

- Type 3: cost of the risks that climate impacts are more
severe than median projections

- Type 4: costs that are felt outside markets, such as
loss of environmental systems and amenity, and
international humanitarian impacts that do not affect
Australian markets.

The Garnaut Review incorporated types 1 and 2 into its model. The
review also included in its analysis the benefits to the economy of
avoiding some of these costs. The Treasury work did not include
the benefits of avoided costs.

. Modelled costs of emissions reductions. The Garnaut
Review and the Treasury both modelled the costs of
emission reductions in the same way.

. Coverage. The Garnaut Review scenarios assume that all
sectors of the economy are covered by the mitigation
policy from the commencement of the modelling period,
whereas the CPRS scenarios assume coverage based on the
Green Paper (for example, the CPRS scenarios assume that
the agriculture sector is excluded until 2015).

. International action

- The CPRS scenarios employ a multi-stage approach to
international emissions trading, whereby all countries
are assumed to have 'business as usual' emissions until
2010, after which countries listed in Annex B to the
Kyoto Protocol apply the same mitigation effort as
Australia. China and higher income developing countries
commit to restraining their emissions from 2015, so that
China's emissions allocation triples by 2030 and then
begin to fall; India and middle income developing
countries take on commitments from 2020, with India's
emissions allocation peaking around 2040; lower income
countries take on similar commitments from 2025.
Emissions allocations within each group, including
advanced countries, are a uniform reduction from each
country's reference case emissions. This results in
total emissions allocations for each group of nations
being between 50 per cent and 80 per cent below
reference scenario levels by 2050, with developing
countries' emissions being higher than their 2000
levels. International trade in permits is unconstrained
from 2020 onwards.

- In contrast, the Garnaut Review scenarios assume that
Australia will take on its proportionate share of global
mitigation on a per capita basis. The model allows for
a transition period to enable the current unequal
distribution of emissions across countries to 'contract
and converge' to equal per capita entitlements in 2050.
Australia is assumed to meet its targets for the first
commitment period of the Kyoto Protocol. All countries
are assumed to continue on business-as-usual growth in
emissions until 2013, when global mitigation efforts
commence with unlimited trading in permits between
countries. This represents a stylised optimal post-2012
framework.

. Emissions-intensive trade-exposed industries. The CPRS
scenarios shield emissions-intensive trade-exposed sectors
until 2020, after which assistance is phased out,
consistent with the preferred position expressed in the
Green Paper. The Garnaut Review scenarios do not include
any shielding of those sectors, as concerted world action
to reduce emissions results in an emissions price emerging
in all countries at the same time.

. Fuel excise. The CPRS scenarios offset the impact of an
emissions price on transport fuels through fuel excise
changes until 2013. In contrast, the Garnaut Review
scenarios assume that the emissions price impact on
transport is fully passed through to consumers.

. Renewable Energy Target. The CPRS scenarios include the
Renewable Energy Target so that 20 per cent of Australia's
electricity comes from renewable sources by 2020. The
Garnaut Review scenarios assume that Australia does not
have a Renewable Energy Target once emissions trading
commences.

. Long term emissions reduction target. An emissions
reduction scenario needs to specify both a start point and
an end point in order to describe the shape of the path
between the two points. The CPRS scenarios are consistent
with the Government's stated 2050 target of a 60 per cent
reduction below 2000 levels. The Garnaut Review scenarios
involve Australian emissions reductions to 80 per cent and
90 per cent below 2000 levels by 2050. It is important to
note that these 2050 targets are assumptions; they are not
results of projections by the models.

Emissions reduction scenarios used for analysis

The consequences of different national trajectories and
international arrangements were explored through six stylised
scenarios.

In the Garnaut Waiting Game scenario, emissions trading is
implemented in 2010 without any clarity about the long-term
coverage or ambitions of the likely international agreement to
reduce greenhouse gas emissions. This scenario does not include a
2020 target, and the carbon price is fixed. The aim would be to
'keep hopes alive of an international agreement at reasonable cost,
until all opportunities had been exhausted'. The Garnaut Final
Report suggests that this outcome is unlikely, given commitments by
the governments of developed countries.

In the Garnaut Copenhagen Compromise scenario, emissions trading
commences with a partial (rather than a comprehensive)
international agreement to reduce greenhouse gas emissions, and the
carbon price is fixed between 2010 and 2013. Under this scenario,
the Garnaut Final Report suggests that Australia would reduce
greenhouse gas emissions by 5 per cent below 2000 levels by 2020.
Like the Waiting Game scenario, the Copenhagen Compromise is
assumed to be a transitional scenario that will be superseded by a
more ambitious global agreement.

In the Garnaut 550 ppm scenario, emissions trading begins with a
comprehensive global emissions reduction agreement in place,
centred on the long term stabilisation of global atmospheric
greenhouse gases at 550 ppm CO2-e. All countries take on
obligations from 2013, with the per capita emissions allowances of
fast-growing developing countries rising until they meet the per
capita levels of the European Union and Japan, and then converging
on equal global allocations by 2050. The Garnaut Final Report
suggests that, under this scenario, Australia would reduce
greenhouse gas emissions by 10 per cent below 2000 levels by 2020.

The Garnaut 450 ppm scenario is similar to the Garnaut 550 ppm
scenario, but the assumed global agreement is centred on long term
stabilisation at 450 ppm CO2-e. The Garnaut Final Report suggests
that, under this scenario, Australia would reduce greenhouse gas
emissions by 25 per cent below 2000 levels by 2020. Mitigation
costs associated with the Garnaut 550 ppm and Garnaut 450 ppm
scenarios were modelled by the Treasury, and the results were also
published in Australia's low pollution future.

Australia's low pollution future presented a further two scenarios:
the CPRS - 5 scenario and the CPRS - 15 scenario. These include the
impact of the scheme as presented in the Green Paper, and achieve
reductions by 2020 of 5 per cent and 15 per cent, respectively,
below 2000 levels. Both assume a staged approach to international
action, with developing countries joining the system over the
period from 2015 to 2025 as described above. Australia's low
pollution future locates CPRS -5 in a global scenario that would
stabilise global atmospheric greenhouse gases at around 550 ppm CO2-
e by the end of the century; and CPRS -15 in a global scenario with
stabilisation at around 510 ppm CO2-e.

Key results from economic modelling

Australia's low pollution future found that all the emissions
reduction scenarios modelled involved only slightly slower economic
growth than the reference case. Consistent with other Australian
and international modelling, annual GNP (gross national product)
and GDP (gross domestic product) growth is around 0.1 per cent
lower over the period to 2050 than it would be without policy
action. This results in per capita GNP (measured in 2005 dollars)
rising from $50,400 in 2008 to between $54,700 and $55,200 in 2020
across the four scenarios, rather than $55,900 in 2020 in the
reference case. GNP is 1.3 per cent to 1.7 per cent below the
reference case in 2020 in the CPRS scenarios, and up to
2.0 per cent below the reference case in the Garnaut Review
scenarios.

These impacts are equivalent to about 4 months of economic growth,
implying that the level of economic activity achieved in January
2020 in the reference case would be achieved in April 2020 in the
CPRS scenarios.

Table 2.3 summarises results from Australia's low pollution future
and the Garnaut Final Report.

Table 2.3: Summary of results of modelled scenarios

| |Refer-ence caseb |
|[pic] |[pic] |

Note: These charts are illustrative only and should not be
interpreted as actual emissions trajectories.

The first indicative trajectory should be calculated by taking the
likely net emissions position for 2007-08 and assigning the
remaining emissions budget from the first Kyoto commitment period
to the four remaining years of that period, on the basis that
national emissions will peak with the introduction of the scheme in
2010-11 and then trend downwards with relatively gentle reductions
in the initial years.

The level of the peak and gradient of the slope are consistent with
Australia's Kyoto Protocol target of 108 per cent of 1990 emissions
on average over the first commitment period. The choice of this
trajectory provides additional liquidity at the start of the
scheme, by drawing on the flexibility mechanisms provided by scheme
design choices such as the banking of permits. This will help to
provide more market depth and assist the management of carbon price
uncertainty as the market is being established.

That is, the first indicative trajectory should be:

. in 2010-11, 109 per cent of 2000 levels

. in 2011-12, 108 per cent of 2000 levels

. in 2012-13, 107 per cent of 2000 levels.

This indicative short-term trajectory provides some early clarity
to business about the possible future scheme cap setting policies
in 2010. Business can plan with some assurance that the scheme
caps as set in 2010, will be guided by the indicative pathway
outlined above, which peaks in 2010-11 and then trend downwards,
but remaining consistent with our Kyoto commitments, which retains
flexibility to address different pathways following further
international negotiations. As noted earlier, providing these
clear signals about the Government's policy intent through the
medium-term target range and the trajectory allows businesses to
form judgments about medium- and long-term carbon prices and
facilitates appropriate risk management and planning in the near
term.

3) Coverage

The coverage of the Carbon Pollution Reduction Scheme is an
important consideration for Government. It determines how much of
Australia's emissions are captured by the scheme and plays a large
role in determining who bears the costs associated with reducing
emissions and, to a degree, how significant these costs are.

The consideration of coverage has two broad elements:

. Which gases should be covered by the scheme?

. Which sectors should be included in the scheme?

For each sector included in the scheme, additional considerations
are:

. At what point in the supply chain should the obligation to
report emissions and surrender permits be imposed?[13]

. Should the threshold for inclusion in the scheme be
different to the 25 kt CO2-e/year facility level threshold
applicable under NGERS?[14]

Objectives

In deciding on the coverage of the scheme the Government is
pursuing two broadly competing objectives.

On the one hand, the coverage of the scheme should be broad,
capturing as many sources of emissions as possible. The wider the
scope of the scheme, the more the costs of pursuing a particular
emissions reduction target are spread across the economy. In
addition to ensuring that costs are shared more fairly amongst
industries, it also helps to reduce the risks of the carbon
pollution reduction scheme distorting the flow of investment toward
different sectors. Expanding the ambit of the scheme also opens up
additional abatement opportunities ensuring that the cheapest
abatement options are pursued, thereby reducing the overall cost to
the economy of pursuing any given target (see box 3.1).

|Box 3.1: The benefits of wider coverage |
|For any particular scheme cap the Government may |
|choose, a particular level of 'abatement' is |
|required. Abatement refers to activities that will |
|reduce emissions of greenhouse gases or 'sequester' |
|(absorb) greenhouse gases already released into the |
|atmosphere. The costs of this abatement are likely |
|to vary across sectors and industries and even |
|between different businesses in the same industry. |
|That is, some businesses will have cheaper options |
|for reducing emissions than others (these options |
|may include changing energy sources, changing |
|production methods to become more efficient or |
|changing the composition of products to use less |
|carbon intensive inputs). |
|Abatement under the scheme will only be undertaken |
|by 'covered' sectors. That is, sectors which are not|
|included in the scheme will have no obligation or |
|incentive to reduce emissions. |
|If the coverage of the scheme were to be narrow, all|
|required abatement must be undertaken by a smaller |
|number of emitters and a narrower number of |
|technological sources. For instance, if the scheme |
|only covered electricity generation, all abatement |
|required to reach the scheme cap would need to be |
|undertaken in the electricity generation sector. |
|This abatement might come from changes to |
|electricity sources such as increased deployment of |
|wind and solar generation. While some of these |
|abatement opportunities are likely to be low cost |
|(wind generation is already being deployed in some |
|areas) as higher levels of abatement are required |
|the cost will rise. For instance wind generation |
|would need to be sighted in less productive (less |
|windy) areas or more expensive technologies would |
|need to be deployed to further reduce emissions and |
|meet the scheme cap. |
|It is likely that other sectors would offer |
|abatement opportunities at lower cost than |
|undertaking all abatement in the electricity |
|generation sector. For instance, the capture and |
|flaring of waste methane from landfill sites can |
|reduce emissions at relatively low cost (it is |
|already undertaken in some areas even in the absence|
|of a carbon price). Including the waste sector in |
|the scheme would provide an incentive to undertake |
|these lower cost abatement projects and reduce the |
|need for higher cost abatement in other areas (the |
|electricity generation sector in this example). |
|Qualitatively, it is clear that, by opening up |
|additional abatement opportunities, expanding scheme|
|coverage will reduce the costs of meeting any |
|particular scheme cap. Moreover, it is expected |
|that these benefits would be significant - in |
|reporting it's modelling results (which assumed wide|
|scheme coverage) the Treasury note that: |
|Emission reductions occur at different rates across |
|sectors and over time. The ability to reduce |
|emissions when it is cheap to do so, through a |
|market based mechanism, keeps mitigation costs as |
|low as possible.[15] |
|It is instructive to note that the overall costs of |
|the scheme are large - in the order of 1.3 to 2 per |
|cent of GNP in 2020 (with wide scheme coverage).[16]|
|Even relatively small reductions in the cost of |
|abatement would have significant absolute benefits |
|in terms of the reducing the overall cost of |
|abatement under the scheme. The modelling did not |
|examine the impact of excluding particular sectors |
|from the scheme. |
|However, it is not feasible to quantify the benefits|
|of expanding coverage to particular sectors. To |
|undertake such quantification would require |
|information on the quantity of cost effective |
|abatement opportunities available in each sector at |
|different permit prices. The Government does not |
|have this information. |
|It should be noted that this lack of information is |
|a key reason why an emissions trading scheme (a |
|market based method) has been adopted to reduce |
|emissions. Even in the absence of this information |
|an emissions trading scheme, which allows businesses|
|to trade permits, should result in the most cost |
|effective abatement opportunities being pursued |
|first.[17] Regulatory approaches (as opposed to |
|market based approaches) to reducing emissions rely |
|on Government being able to identify cost effective |
|abatement opportunities and regulate for abatement |
|in these areas. |
|Overall, there are benefits to expanding scheme |
|coverage and it is expected that these benefits will|
|be significant. However, it is not possible to |
|quantify these benefits in such a way that would |
|allow meaningful quantitative comparison with the |
|additional compliance costs associated with |
|expanding scheme coverage to particular sectors. |

On the other hand covering some sectors or industries may impose
significant compliance costs on those industries. This is likely to
be the case where there are a large number of small emitters and no
practical way of ensuring compliance with the scheme. It is also
likely to be a problem where the methodology for measuring
emissions has not yet been developed or is highly unreliable.

Overall, when deciding on whether or not to include particular
sectors, the objective is to cover as much of Australia's emissions
profile as possible, while not imposing undue compliance costs on
business or depending on unreliable measurement methods.

In considering compliance costs it is important to note that in
many cases businesses are already subject to a significant portion
of the compliance cost burden associated with the scheme. This is
because many sectors already have to comply with the National
Greenhouse and Energy Reporting System (NGERS). Under this system,
a controlling corporation's group which controls a facility that
emits more than 25 kt CO2-e/year (and a controlling corporation's
group whose facilities emit (in total) more than 125 kt CO2-e/year
(falling to 50 kt CO2-e/year in 2010-11)) must report their
emissions to the Greenhouse and Energy Data Officer.

Where businesses are already recording and reporting emissions, the
additional compliance costs mainly relate to changes in accounting
practices, assurance of emissions, management reviews and modelling
and education of personnel. Box 3.2 gives more detail on the
estimation of compliance costs including overall estimates of
compliance costs.

In addition to compliance costs, businesses and sectors covered by
the scheme will also incur substantial costs associated with
purchasing permits to cover emissions or undertaking abatement
activities to reduce emissions. In many cases these costs can be
passed on to consumers, although this will result in a reduction in
demand which will be detrimental to the business. In other cases,
companies will be less able to pass on costs and will bear these
costs themselves. [18]

While the majority of the impacts of decisions in regard to
coverage of the scheme fall on business (and these are the impacts
under consideration in this chapter), there will be some (small)
impacts on consumers and government (see box 3.3).

|Box 3.3: Coverage impacts on consumers and |
|government |
|The major impact on consumers associated with |
|expanded coverage will stem from the reduction in |
|overall abatement costs. While the cost reduction |
|described in Box 3.1 will initially accrue to |
|businesses (who must undertake the abatement) these |
|benefits will be passed onto consumers through |
|reduced average prices overall (reflecting more |
|efficient abatement) and higher incomes (reflecting |
|slightly faster economic growth). That is, the |
|impacts eventually passed on to consumers under a |
|scheme with wide coverage will be less significant |
|than under a scheme with narrow coverage. |
|The one area where there may be costs for some |
|consumers is in relation to the process of some |
|goods and services. While on average price increases|
|would be lower (assuming that a similar share of |
|abatement costs are passed on to consumers across |
|the economy), expanding the coverage of the scheme |
|will lead to relative price increases in different |
|areas. For instance, including the waste sector in |
|the scheme is likely to result in higher local |
|government charges as they pass on the costs |
|associated with emissions abatement in the waste |
|sector. Similarly, including synthetic greenhouse |
|gases is likely to lead to small increases in the |
|price of goods such as refrigerators and air |
|conditioners that use these gases. Consumers that |
|have a particularly high consumption of these goods |
|and services will be most affected by their |
|inclusion in the scheme. However, the overall costs |
|of scheme coverage decisions on consumers are |
|expected to be limited (especially in comparison to |
|business compliance costs). |
|For Government, the administrative costs associated |
|with expanded scheme coverage are expected to be |
|limited. The major costs associated with running the|
|scheme, such as auction design and operation and |
|establishment of the regulator, will be undertaken |
|regardless of the sectors covered under the scheme. |
|It is also important to note that Government costs |
|associated with reporting emissions are already |
|incurred as a result of NGERS. One area where the |
|Government may incur additional administrative costs|
|is if additional assurance activity is undertaken as|
|a result of covering additional businesses under the|
|scheme (see chapter 4 for a discussion of auditing |
|and assurance). Again, in comparison to the |
|compliance costs for businesses, these costs are |
|expected to be small. |

Which gases should be covered?

Parties to the Kyoto Protocol account for six greenhouse gases that
contribute most to human-induced climate change (listed in table
3.1).

In designing a domestic emissions trading scheme, one option would
be to include only the most common greenhouse gases or those that
can be most easily estimated on commencement, with the remaining
greenhouse gases included over time. For example, the EU scheme
began by covering only carbon dioxide. This option would not
necessarily simplify the scheme and could complicate emissions
reporting. Under NGERS entities are already responsible for
reporting emissions of all six greenhouse gases from their
facilities. If the trading scheme only covered carbon dioxide (for
instance) companies would have to separately estimate the quantum
of carbon dioxide released from their facilities rather than
relying on existing estimates of emissions. This option would also
limit scheme coverage and create discrepancies between the scheme's
emissions reporting and the reporting in Australia's national
emissions inventory (which forms the basis for international
obligations).

An alternative option would be for the scheme, from commencement,
to cover all the greenhouse gases included in the Kyoto
Protocol.[19] As this approach is consistent with current reporting
obligations, it would not add to implementation risks or to
compliance costs. This option would ensure that the incentives
created by the scheme align with the desired environmental goal as
defined under the international climate change framework.

The preferred option is for the scheme to cover all six 'Kyoto'
gases from commencement.

Table 3.1: Kyoto Protocol gases-global warming potential

|Kyoto gases |Global warming potentials|
|Carbon dioxide (CO2) |1 |
|Methane (CH4) |21 |
|Nitrous oxide (N2O) |310 |
|Sulphur hexafluoride |23,900 |
|(SF6) | |
|Hydrofluorocarbons (HFCs)|140-11,700 |
|Perfluorocarbons (PFCs) |6,500-9,200 |

Source: Intergovernmental Panel on Climate Change Second Assessment
Report: The Science of Climate Change.

Which sectors should be covered?

The Kyoto Protocol sets out seven sectors for reporting human-
induced greenhouse gas emissions:

. Stationary energy: primarily carbon dioxide emissions from
fuel combustion for electricity generation, and energy
production in the petroleum refining, manufacturing,
construction and commercial industries and for domestic
heating

. Transport: primarily carbon dioxide emissions from the
direct combustion of fuels for road and rail transport,
domestic aviation and shipping

. Fugitive emissions: methane, carbon dioxide and nitrous
oxide emitted during the production, processing,
transport, storage and distribution of coal, oil and gas

. Industrial processes: emissions from chemical reactions
associated with manufacturing processes, mineral
processing, and chemicals and metal production

. Waste: primarily methane and nitrous oxide; includes
emissions from solid waste sent to landfill and from the
treatment of domestic, commercial and industrial
wastewater; and solvent and clinical waste incineration

. Land use, land-use change and forestry: in this sector,
only emissions from land-use change activities -
reforestation and deforestation - are counted towards
Australia's Kyoto target:

- Agriculture: primarily methane and nitrous oxide from
livestock and cropping

- Reforestation: conversion of land used for other
purposes to forested land

- Deforestation: conversion of forested land to
alternative land uses.

Figure 3.1 sets out Australian emissions in each sector.

Figure 3.1: Australia's national emissions profile in 2006

[pic]

Source: National Greenhouse Gas Inventory 2006, Department of
Climate Change

This section looks at the merits of including each sector in the
scheme. As outlined above, where these sectors are covered, it also
looks at who should be responsible for reporting emissions and
surrendering permits.

A separate subsection of this paper (which follows stationary
energy and transport - the principle fuel users) looks at the role
of the fuel (coal, gas, petroleum) production and distribution
sector in reporting emissions and surrendering permits. While
entities in this sector are not directly responsible for the
emissions resulting from the combustion of the fuel they produce,
imposing reporting requirements at this stage may be more efficient
than imposing requirements on the downstream users (the 'direct'
emitters).

Stationary energy

Stationary energy contributes around 50 per cent of Australia's
emissions and is the fastest growing source of emissions.[20] Most
emissions from this source are from the electricity generation
sector, which consists of around 100 large facilities. The
remaining emissions are from direct combustion of fuels by large
and small emitters in the petroleum refining, manufacturing and
construction industries, with small contributions from home
heating, on-site diesel generation, and on-farm machinery.

Site-specific emissions estimation methodologies are used to
estimate emissions from most large emitters.[21]

Obligations could be applied under the scheme to every household
that combusts fuel. However this would have very high compliance
and administrative costs.

Around 90 per cent of emissions from this source can be covered by
applying direct scheme obligations to around 100 power generation
facilities and to around 200 large manufacturing facilities whose
emissions exceed 25 kt CO2-e/year (the existing NGERS reporting
threshold).[22] Estimates of compliance costs for large stationary
energy emitters are between $904,550 and $281,757 (start up costs)
and $274,176 and $50,969 (annual ongoing costs). Using company
numbers described in box 3.2, this would imply total compliance
costs of around $93 million (start up) and $31 million (ongoing).

Because stationary energy contributes a large and growing
proportion of emissions to Australia's total emissions, coverage of
this sector is critical to achieving any substantial cuts in
emissions.

The remaining 10 per cent of stationary energy emissions could be
covered by lowering the emissions threshold. Depending on the
threshold chosen, this could result in coverage of small entities,
whose participation in the scheme would not be cost-effective. That
is, the compliance costs associated with imposing scheme
obligations on these entities would be significant given their
emissions levels.

An alternative option is to impose scheme obligations for the
remaining stationary energy emissions on upstream suppliers of
coal, natural gas and liquid fuels. That is, rather than directly
paying (in the form of permits) for the emissions, smaller emitters
would pay higher fuel prices as upstream fuel suppliers purchase
permits to cover emissions from the use of the fuel and pass on the
costs to downstream users. This approach would involve fewer
additional compliance costs as there will be far fewer upstream
suppliers and in many cases they are also likely to have scheme
obligations for their direct emissions (and therefore already incur
significant compliance costs as a result of the scheme). This
option would also achieve near universal coverage of emissions,
where as the alternative (lowering the threshold would still leave
a portion of emissions uncovered).

All Green Paper submissions on the issue were supportive of the
Government's proposed inclusion of stationary energy.

The preferred approach is to cover all entities whose emissions are
greater than 25 kt CO2-e/year. While this would entail significant
compliance costs, the share of emissions associated with this
sector make its inclusion in the scheme critical. These costs would
be greater if there was a lower threshold. Entities with emissions
less than 25 kt CO2-e/year would be covered indirectly via
obligations on upstream fuel suppliers. Specific obligations for
each type of fuel are discussed below.

Transport

Transport emissions account for around 14 per cent of Australia's
emissions. Road transport contributes almost 90 per cent of
transport emissions, with the remainder coming from rail, domestic
aviation and shipping.[23]

Australia has millions of motorists and a significant number of
freight companies, making it impractical and/or costly to apply
scheme obligations directly to these emitters. Restricting coverage
to large direct emitters, such as freight companies whose emissions
exceed 25 kt CO2-e/year and who have obligations under NGERS would
result in coverage of only 30-40 per cent of transport emissions.
It would also lead to significantly different impacts on closely
competing freight companies on either side of the emissions
threshold.

As a result, the only feasible option for including transport in
the scheme is to apply the scheme requirements to upstream fuel
suppliers. This would impose obligations on around 250 upstream
producers (petroleum suppliers). As discussed in box 3.2, the
compliance costs associated with imposing obligations on upstream
(excisable) fuel suppliers is estimated to be around $78 million
(start up costs) and $18 million (annual ongoing costs).

As with expanded coverage generally, the benefits associated with
coverage of the transport sector is that it opens up additional
abatement opportunities and lowers the overall cost of meeting any
given scheme cap. Abatement in the transport sector is likely to
occur through substitution in transport modes (For instance by
taking public transport instead of driving and using rail for
freight instead of road transport) and substitution toward more
fuel efficient vehicles.

The Government has already decided (as part of the Green Paper
process) that if transport is included in the scheme, it would
offset the effects on households, on-road business users and
agricultural and fishing industries for the first three years of
the scheme. Heavy vehicle road users will have the initial impact
of the scheme offset for the first year. This will occur through a
cent for cent reduction in excise which will offset the increase in
fuel prices associated with the introduction of the scheme.

There was strong support for inclusion of transport in the scheme
(state governments, National Transport Commission, BP, Tourism and
Transport Forum, QR Ltd) both as a large source of emissions in
Australia and also to reduce abatement costs through maximal
coverage. One concern related to the effectiveness of including
transport at this point in time, given that the Government has
already committed to offsetting the impacts of the CPRS for the
first three years. As discussed below (in the context of covering
petroleum), the preferred position at this stage is to cover
transport from the beginning of the scheme. Such coverage will also
drive changes in the behaviour of consumers considering purchase of
new vehicles leading up to and during the transition period. Other
stakeholders argued for additional complementary measures,
including vehicle efficiency standards and investment in public
transport, to assist the transition to lower emission forms of
transport (in a sector with a relatively low elasticity of demand).
While there may be merit in adopting complementary measures if
transport were permanently excluded from the scheme, the
administrative and compliance costs associated with establishing
such measures would not appear to be warranted in the context of
the limited period of offsetting implied by the Governments
commitment.

Overall, transport accounts for a significant portion of emissions
in Australia and the sector also has opportunities for abatement.
As a result, its coverage in the scheme would entail significant
benefits. While there are also compliance costs associated with
it's coverage, the judgement is that the benefits of including
transport outweigh these costs. This is the preferred option.

Fuel suppliers

As discussed above the most efficient way of covering emissions
from small emitters in the transport and stationary energy sectors
is to place obligations on fuel suppliers rather than directly on
the emitting entity. The amount of greenhouse gas emissions from
most fuel sources is directly related to the quantum of fuel burnt.
As a result fuel suppliers would know that a unit of fuel, once
burnt, would yield a particular quantum of greenhouse gases using
national default methodologies and would need to purchase enough
permits to cover these emissions. The cost of the permits would be
included in the price of the fuel thereby providing an incentive
for users to reduce fuel use and greenhouse gas emissions.

For the purposes of determining the best way of covering fuel in
the scheme, suppliers can be split into two categories:

. those who are covered under existing excise and customs
duty arrangements (mostly suppliers of petroleum products)

. other suppliers who are not covered by excise and customs
duty arrangements (such as coal, natural gas and LPG
suppliers).

Petroleum suppliers

Suppliers and distributors of petroleum products are liable to pay
excise and excise-equivalent customs duty on these products. The
excise and customs duty arrangements provide a well established
administrative framework for determining the amount of fuel
supplied, netting out fuel sold internationally and to other liable
entities (to remove double counting) and ensuring compliance with
excise and customs law. The existence of the excise arrangements
provides a unique vehicle to use for the purposes of the scheme. As
fuel suppliers and distributors already know the quantum of fuel
supplied (this is reported to the Australian Taxation Office and
Australian Customs Service on a regular basis) all that would be
required under the scheme is that they surrender a quantum of
permits to cover emissions from the combustion of this fuel. Using
an existing reporting mechanism reduces any additional compliance
costs that would come from establishing a new system.

It is estimated that there are around 250 entities responsible for
remitting excise or customs duty on petroleum products. These
entities would incur direct liabilities under the scheme (that is
they would need to obtain and surrender permits). Unlike all other
areas of the scheme (where the 25 kt CO2-e/year limit is likely to
ensure that small businesses are not captured by the scheme) a
number of the fuel excise remitters are small business. The
majority of petroleum products are supplied by around 4 major
refiners/importers, 5 smaller independent operators and 10 fuel
blenders. The remaining entities are small suppliers such as
biofuel producers, fuel suppliers in remote areas, mining companies
that import fuel directly and 'joint user hydrant' installations
that supply fuel at airports (a number of which are likely to be
small businesses).

As discussed in box 3.2, the compliance costs associated with the
inclusion of upstream petroleum suppliers are estimated to be
around $78 million (start up) and $18 million (ongoing). This
assumes that there are 20 large liquid fuel suppliers (refineries,
blenders and importers) who are represented by hypothetical company
E (the petroleum refiner with start up costs of $663,675 and
ongoing costs of $311,915) and 230 smaller suppliers who are
represented by company F (the small-medium manufacturer with start
up costs of $281,757 and ongoing costs of $50,969).

While other options for covering petroleum suppliers exist (such as
covering major liquid fuel suppliers only), these approaches could
require a new framework for estimating supply and ensuring
compliance. The compliance and administration costs of these
approaches would be much greater than basing requirements on
existing excise and customs duty arrangements. Moreover, this would
not result in comprehensive coverage of petroleum fuel emissions.

In response to the Green Paper, stakeholders agreed that piggy
backing on the excise and customs duty arrangements was the least
costly and most efficient approach.

The one concern raised was in relation to the interaction of the
excise and customs duty system with the Government's planned cent
for cent rebate and its implementation. Stakeholders, such as BP,
the Energy Supply Association of Australia, the Australasian
Railway Association and the Australian Shipowners Association,
questioned the need to include petroleum in the scheme if the
Government was planning to offset the effects of its inclusion.
Compliance costs would be minimised by utilising the existing
arrangements of the tax system to implement the cent for cent
offset. This avoids setting up a new and potentially complex,
expensive framework for a transitional measure. The offset
arrangements will be reviewed for heavy vehicles after one year and
for households, on-road business users and agricultural and fishing
industries after three years. Many fuel suppliers would have
significant direct emissions from other activities (such as
refining and industrial processes) and would need to be involved in
the scheme to cover these emissions. As a result they will already
need to set up the administrative and compliance arrangements
associated with the scheme. Moreover, the administrative
arrangements for permit acquittal will need to be in place
following the end of the offset period anyway.

As a result it is still proposed to cover all fuel suppliers from
the beginning of the scheme regardless of the cent for cent
commitment. In the case of liquid fuels currently subject to excise
and excise-equivalent duty, the preferred approach is to apply the
scheme requirements on all excise and customs duty remitters.

Other fuel suppliers

Other fuel suppliers cover the supply of natural gas, coal,
liquefied natural gas (LNG), compressed natural gas (CNG), and
liquefied petroleum gas (LPG). These fuels are used by a wide range
of large and small emitters in the stationary energy and transport
sectors as well as being used as feedstock in the plastics and
chemicals industries. For instance, LPG is a common alternative to
petrol in the transport sector. Natural gas is used in the
generation of electricity, in many industrial processes and
domestically by households.

Comprehensive coverage of the emissions from these fuels can be
achieved by covering all producers and importers. In most cases
this would entail coverage of a relatively small number of
entities. There are only around 14 suppliers of LPG, 30 natural gas
producers and 6 suppliers of brown coal products (including five
mines and one briquette supplier) and a number of these companies
will be liable under the scheme for other reasons (that is they are
also a mining company or petroleum refiner). Although, in the case
of black coal, there are more than 200 coal mines, washeries and
distributors. Most of these entities will be large emitters of
greenhouse gases in their own right (direct emissions greater than
25 kt CO2-e/year) and will have to participate in the scheme in any
case. As a result, the compliance costs associated with using these
entities to report on fuel sales and surrender permits accordingly
would not appear to be highly significant.

However, there are two significant drawbacks to covering all fuel
at this point in the supply chain, particularly related to supply
chains involving intermediaries between the supplier and the end
user. Firstly, it would not allow large fuel users (with emissions
exceeding 25 kt CO2-e/year) to manage their own liabilities under
the scheme in situations where there is no contractual relationship
between the supplier and the large user. Instead these entities
could potentially face a higher fuel cost associated with the
suppliers permit acquisition and liability management strategies.
Large emitters are likely to find this approach sub-optimal as it
removes from their control the ability to directly manage
liabilities accrued under the scheme and these are likely to be
significant liabilities for many entities. Secondly, the specific
end use of a fuel cannot necessarily be determined by an upstream
supplier and therefore accurate emissions estimation might not be
possible. For example, in the case of LPG, the emissions resulting
from LPG combusted as a transport fuel are different to the
emissions resulting from LPG combusted for stationary energy.

To overcome these issues, an administrative mechanism could be
established to enable scheme liabilities to be transferred from
upstream producers and importers of fossil fuels to downstream
entities (such as marketers, distributors and retailers).
Arrangements would be required to allow suppliers to 'net out' fuel
sold to large emitters, fuel used as a feedstock and fuel that is
not covered under the scheme (including fuel that is exported, fuel
used in international shipping, fuels supplied to visiting defence
forces), by providing the supplier of the fuel with an Obligation
Transfer Number. This will allow marketers, distributors and
retailers to take responsibility for scheme obligations for fuel
sold to smaller users. Importantly it would also allow these large
emitters to directly manage their scheme obligations including
decisions relating to the timing and source of permit purchases,
abatement opportunities and hedging choices. It is also important
to note that this group of companies would include many of the
largest emitters in Australia. Their involvement is seen as being
critical to the development of the scheme.

This would imply that the fuel price paid by small users would
include the cost of permits while the fuel cost paid by large users
would not. An appropriate threshold would be 25 kt CO2-e/year as
this is, for the most part, the threshold at which businesses are
required to report emissions under the NGERS. Companies under this
threshold would have no scheme requirements and as a result incur
no compliance costs (though they would face higher fuel costs).

Netting out arrangements would result in additional compliance
costs as a small additional number of companies are likely to be
involved in the scheme, and because compliance with the scheme is
now more complicated. Companies would be required to keep track of
both fuel supplied inclusive of a carbon price as well as fuel
supplied under an Obligation Transfer Number. In some cases, these
compliance costs will be greater (for instance for a natural gas
distributor supplying to a large number of small and large
emitters) in other cases they are likely to be small (for instance
for a coal mine supplying only a few large emitters).

In all, it is estimated that the compliance costs for companies
affected by this option would be around $70 million (start up
costs) and $41 million (annual ongoing costs). As discussed in box
3.2, this is based on 24 gas supply companies and 138 mining
companies. Many of these companies will already be liable for their
own emissions and additional costs associated with these 'upstream'
activities will only represent a portion of these costs.

A number of intermediaries (marketers, distributors and retailers)
supported their inclusion in the scheme as being a more appropriate
point of obligation than further upstream. For instance the
Australian LPG Association (LPGA) argued that:

To ensure that coverage is as close as possible to the
point of end-use, and that costs and pass-through can be
most efficiently managed, LPGA recommends that the primary
point of obligation for LPG is by marketers

Similarly Shell Australia noted that:

Being able to identify the use of the LPG is important in
determining emissions obligations under the CPRS

A more limited number of retailers (such as Energy Australia)
considered that the obligation for surrendering permits for the use
of gas by small users should apply to gas producers rather than to
retailers. However, as discussed above, there are significant
drawbacks to this approach as gas producers will often have
incomplete information about the final use of the gas (and
therefore the liability for permits).

In all, the preferred approach is for scheme obligations to apply
to upstream fuel suppliers (including producers and importers) who
would 'net out' sales to Obligation Transfer Number holders
(including large emitters, marketers, distributors and retailers).
While this approach has additional compliance costs, the ability of
large emitters to directly participate in the scheme is crucial to
the scheme. It is also beneficial to exclude the cost of carbon
from fuel used as feedstock and fuel not covered by the scheme. The
benefits of netting out (to individual companies and the scheme
more generally) is judged to outweigh the additional compliance
costs.

Fugitive emissions

Fugitive emissions account for around six per cent of Australia's
emissions. [24] Fugitive emissions are released in the course of
oil and gas extraction and processing; through leaks and deliberate
releases from gas pipelines; and as waste methane from black coal
mining. Most fugitive emissions occur from facilities that emit
more than 25 kt CO2-e/year (around 120 coal mines and fewer than 50
gas producers and distributors).

There are both national default emission factors and site-specific
emissions estimation methodologies for fugitive emissions from oil
and gas production.

At present, facilities that emit more then 25 kt CO2-e/year are
already required to report emissions under the NGERS requirements.
Including these facilities in the scheme would cover a significant
portion of national emissions (with the attendant benefits of
opening up opportunities for abatement and spreading the burden of
emissions reductions more widely). Compliance costs of including
fugitive emissions are estimated to be around $396,210 to $373,217
(start up) and $278,320 to $291,059 (ongoing) per business.
Assuming 114 companies responsible for fugitive emissions, total
compliance costs would be around $45 million (start up) and $32
million (ongoing).[25] It should be noted that most of these
emitters will also have liabilities under the scheme as a result of
being upstream suppliers of coal and gas products. It is estimated
that there are 12 additional fugitive emitters which do not have
liabilities elsewhere. The compliance costs for these companies
alone is around $5 million (start up) and $3 million (ongoing)
(this is included in the above estimate).

As with other scheme coverage considerations, the benefits of
including fugitive emissions are that it expands abatement
opportunities and reduces the overall costs of meeting any given
scheme cap. Abatement opportunities in this area include the
capture and use of coal seam methane for power generation or
flaring to reduce emissions. For large emitters the benefits of
expanded coverage are judged to outweigh the compliance costs
associated with the inclusion of fugitive emissions.

A question remains as to whether and how to cover fugitive emitters
who emit less than 25 kt CO2-e/year. It would appear that
relatively few emissions originate from such emitters. As such,
covering these sources would result in relatively few opportunities
to abate and would impose additional compliance costs on these
emitters (as they have no obligations under the NGERS). While there
is the possibility that excluding these emitters from the scheme
would introduce distortions between covered facilities and
facilities below the threshold, those distortions, if they occur,
are likely to affect relatively few facilities.

Few stakeholders commented on the proposed inclusion of fugitive
emissions in the scheme. Those who did, including the Australian
Coal Association, Xstrata and Rio Tinto, focussed on the inclusion
of open cut coal mines in the scheme. Emissions from open cut coal
mines are variable with some emitters falling below the level
implied by the internationally agreed default factor and some
falling above it. As such, using the default factor would result in
benefits to some producers (from underestimation of emissions) and
costs to other users. Fugitive emissions from open cut coal mines
can also be estimated using a site specific methodology. Companies
with emissions above the default average could benefit from using
this method. While fugitive emissions, or more specifically
fugitive emissions from coal mines, could be removed from the
scheme until more accurate methodologies are adopted across the
industry, this would remove a significant portion of emissions from
the scheme and impose costs on other covered entities. It may also
act as a disincentive to adopt more accurate methodologies for
measuring fugitive emissions from open cut coal mines.

The preferred approach is to include fugitive emissions from
facilities with emissions greater than 25 kt CO2-e/year from all
sources. Facilities with fugitive emissions, but with less than 25
kt CO2-e/year from all sources, would not be included in the
scheme.

Industrial processes

Industrial process emissions account for around five per cent of
Australia's emissions.[26] These emissions are from chemical
reactions (other than fuel combustion) and include emissions
resulting from consumption of synthetic greenhouse gases-
hydrofluorocarbons (HFCs), perfluorocarbons (PFCs) and sulphur
hexafluoride (SF6). Emissions from synthetic greenhouse gases are
dealt with separately below.

There are internationally approved, site-specific methodologies for
estimating most of these emissions.

The largest individual sources of industrial process emissions are
iron and steel making, cement and lime making and aluminium
smelting. Facilities that emit more than 25 kt CO2-e/year account
for the great majority of industrial process emissions (other than
synthetic greenhouse gases). These facilities already have
obligations to report under the NGERS regime. Moreover, most
industrial processors will have significant stationary energy
emissions and will need to participate in the scheme to cover these
emissions. As a result, the additional compliance costs associated
with covering industrial processes are expected to be minimal.

Stakeholders raised no objection to the inclusion of industrial
processes in the scheme and coverage of this sector is the
preferred option.

Synthetic greenhouse gases

Synthetic greenhouse gas emissions account for around one per cent
of Australia's emissions (or around one-fifth of industrial process
emissions).[27] These emissions are from the use of commercial and
household equipment such as refrigeration, air-conditioning and
high-voltage electrical equipment.

As with other sectors and industries, the inclusion of synthetic
greenhouse gases would increase the coverage of the scheme,
spreading the burden of emissions reductions and introducing
additional abatement opportunities.

Emissions of synthetic greenhouse gases are widely distributed (for
instance amongst refrigerator units and fire fighting equipment).
As a result few emitters have to report under the NGERS scheme and
it would be implausible to cover individual emitters under the
scheme. The only feasible avenue for covering synthetic greenhouse
gases under the scheme would be to require importers and
manufacturers of such gases to surrender permits to cover the
eventual emissions of the gases they introduce into Australia.
Synthetic greenhouse gases are supplied either in bulk or in
equipment such as white goods and air-conditioners. As a result the
key liable parties are likely to be specialist synthetic gas
importers and domestic synthetic greenhouse gas manufacturers (of
which there currently are none). It is expected that no small
businesses will be liable under the scheme after the application of
the 25 kt CO2-e/year threshold discussed below.

Virtually all importers and manufacturers of synthetic greenhouse
gases already have to report volumes of gases imported under the
Ozone Protection and Synthetic Greenhouse Gas Management Act 1989
and this should reduce compliance costs associated with the scheme.
Nevertheless, requiring importers and manufacturers to acquire and
surrender permits under the scheme would impose some additional
compliance costs. It is estimated that the compliance costs would
be around $328,700 (start up) and $67,271 (ongoing) per business.

Importers and manufacturers of SF6 do not currently have reporting
obligations, although a subset of SF6 importers have reporting
obligations for other synthetic greenhouse gases they import. For
SF6 importers and manufacturers without a current reporting
obligation there will be additional compliance costs relating to
reporting but as noted in the RIS for the Ozone Protection and
Synthetic Greenhouse Gas Management Legislation Amendment Bill
2003, these costs are minimal.

While the compliance costs for synthetic gas importers and
manufacturers are lower than for other companies, it may still not
be worth requiring all to be covered by the scheme. There are a
(relatively) large number of companies who import a very small
amount of synthetic greenhouse gases. For instance, imposing a
threshold of 25 kt CO2-e/year would remove most importers from the
scheme while still ensuring that the scheme covered 95 per cent of
emissions from synthetic greenhouse gases. A 25 kt CO2-e/year
threshold would capture approximately 45 companies with compliance
costs of around $15 million (start up) and $3 million (ongoing)
(see box 3.2).

In general stakeholders recognised the need to include synthetic
greenhouse gases in the scheme. However, some stakeholders, in
particular bulk importers of synthetic greenhouse gases, objected
to being covered by the scheme. They were concerned about the cash
flow implications resulting from the imposition of scheme
obligations. Synthetic greenhouse gases have significant global
warming potential and as a result will require a significant number
of permits per ton of emissions. While only small amounts are
imported (relative to the emissions of other gases), the scheme may
still have a significant impact on the price of such gases.
Stakeholders, such as Refrigerants Australia, A Gas, Arkema,
Actrol, VASA, AREMA , DuPont, were concerned that they may suffer
losses as a result of this price increase. It is difficult to see
why stakeholders would suffer a significant loss in this manner.
They will be able to (and expected to) pass on the costs of
coverage, eventually to consumers. Any risks from the differing
timing of liabilities under the scheme and revenue from costs
passed on can be addressed through the purchase of permits on an
ongoing basis (either from Government auctions or the secondary
market). They could even purchase permits ahead of time, which
would give certainty regarding the costs of permits.

In all, the preferred option is to include synthetic greenhouse
gases in the scheme by imposing requirements to acquire and
surrender permits on importers of synthetic greenhouse gases and
domestic synthetic greenhouse gas manufacturers (of which there are
currently none). A threshold of 25 kt CO2-e/year would apply to
ensure that compliance costs are not imposed on small importers and
manufacturers whose inclusion in the scheme would not be cost-
effective.

There are three issues that pertain to the implementation of the
scheme for synthetic greenhouse gases.

The first issue concerns importers and manufacturers of synthetic
greenhouse gases that import or manufacture less than 25 kt CO2-
e/year of these gases. While it would not be cost-effective for
these smaller entities to participate in the Scheme, as scheme
compliance costs would be considerably higher for these smaller
entities than for other scheme participants, excluding them from
the Scheme would create competitive distortions. The
Airconditioning and Refrigeration Equipment Manufacturers
Association noted that 'the introduction of a threshold is fraught
with danger, given the market distortions this entails. The
introduction of a threshold can also lead to the development of
artificial business restructuring and other artificial strategies
to allow firms to come in under the threshold.'

Distortions could be significant for importers and manufacturers of
bulk synthetic greenhouse gases because the cost of permits will
generally be greater than the market price for the synthetic
greenhouse gas. Distortions could also arise between importers and
manufacturers of synthetic greenhouse gases in equipment,
particularly where the permit value of the synthetic greenhouse gas
contained within the equipment is high compared to overall price of
the product. Measures will therefore be developed to remove the
potential for market distortions resulting from the application of
a 25 kt CO2-e/year threshold in this sector.

The second is in relation to synthetic greenhouse gases which are
not captured under the Kyoto definition of greenhouse gases but are
covered under the Montreal Protocol - the hydrochlorofluorocarbons
(HCFCs). These gases are substitutes for covered gases and
contribute to both climate change and depletion of the ozone layer.
The exclusion of these gases from the scheme could result in
substitution (and carbon leakage) to non covered synthetic
greenhouse gases.

A ban on the import and domestic manufacture of HCFC containing
equipment would be consistent with measures implemented in the US,
Europe and Japan and has the advantage of reducing Australia's
reliance on HCFCs in the lead up to the complete phase out of
HCFCs. However, this will not remove competitive distortions where
entities operating existing HCFC equipment compete with entities
using HFCs. As suggested by Refrigerants Australia, 'There will be
an incentive to stay with HCFC equipment, rather than convert to
HFCs'.

To minimise the potential for perverse outcomes for Australia's
ozone protection program, the import and domestic manufacture of
HCFC containing equipment will be prohibited from scheme
commencement. In conjunction with this measure, additional measures
will be developed to minimise competitive distortions that might
otherwise arise between HCFCs and gases covered under the scheme.

The third issue pertains to the treatment of gases which are
destroyed. As destroyed gases are not released into the atmosphere,
there would be no reason to include them in the scheme. However it
is impossible, at the stage of importation or manufacture, to
determine which gases will eventually be destroyed (so
consideration at that point is infeasible). To ensure that proper
credit is given for the destruction of synthetic greenhouse gases
(and the appropriate incentive for their destruction is
maintained), entities will receive scheme permits for gases
destroyed in accordance with scheme requirements for verification.

Waste

The waste sector accounts for just over three per cent of
Australia's emissions.[28] Around 80 per cent of waste sector
emissions are from solid waste to landfill, with the remainder from
wastewater (around 20 per cent) and solvent and clinical waste
incineration (less than one per cent). The sector is not restricted
to dedicated waste facilities - wastewater from some manufacturing
processes is treated on-site at the manufacturing plant.

There are around 450 active solid-waste handling sites in Australia
and well over 300 wastewater sites. However, most waste volume is
managed by larger sites. In the case of landfill, fewer than 100
sites (around 20 per cent) account for more than 80 per cent of
waste volume.[29] These sites are operated by a mixture of local
governments and corporate service providers. Similarly, around
80 per cent of wastewater sites are small facilities, servicing
rural and regional communities.

The waste sector presents a number of opportunities for cost
effective abatement. Indeed some of these are already being
pursued. For example, methane capture is common in the solid waste
and wastewater sectors. An estimated 26 per cent of methane
emissions from landfill sites is either flared or used to generate
renewable energy.[30] In addition, inclusion of waste sector
emissions could be expected to reduce the amount of waste sent to
landfill and encourage alternative waste technologies. In general,
including the waste sector in the scheme is likely to lower overall
abatement costs and provide significant benefits.

At present, waste sector emissions are covered under the NGERS
reporting system, so waste sector facilities that meet NGERS
participation thresholds are already required to have measurement
and reporting procedures in place. Waste sites generated by local
governments are not covered under NGERS, however calculation of
emissions can be estimated using a default factor. The additional
compliance costs associated with scheme participation are estimated
to be around $353,061 (start up) and $58,305 (annual ongoing)
per business.

Most stakeholders indicated in-principle support for waste sector
coverage, but many had serious concerns relating to the accuracy of
measurement protocols.

By their nature, fugitive emissions - which are generally released
in an uncontrolled manner - are more difficult to estimate than
other emissions sources. Technology for directly measuring waste
sector emissions is in its infancy. Emissions vary across most
landfill sites and it can be difficult to obtain an accurate
reading of the overall emissions. Nevertheless, efforts are being
made to develop more effective measures of emissions from landfill
sites. These are being driven by increased Government regulation of
greenhouse gas emissions and by a growing commercial interest in
landfill gas capture for energy generation. While these techniques
are being developed, estimates of emissions can be made based on
proxies such as the volume of waste deposited.

Stakeholders were also concerned about the treatment of emissions
generated from historic waste streams (also known as legacy
emissions). Landfill sites continue to emit greenhouse gases for
decades after their closure. If scheme requirements are imposed on
sites that are close to closure (or indeed already closed) there
are limited opportunities for owners of these sites to recover
costs from 'gate fees'. While this issue is significant, for
operators of sites close to closure there are some options open:

. In many cases, they have contracts with local Governments
which could be renegotiated to cover costs.

. They can engage methane capture technology to greatly
reduce emissions from these sites.

. They can apply for assistance through the Government's
Climate Change Action Fund.

For sites that are already closed, passing on costs directly is
infeasible. In addition, there are a large number (possibly
thousands) of small, closed sites scattered throughout Australia.
Many now have alternative uses. While most of these sites could be
expected to fall below participation thresholds, the costs of
identifying them and assessing their participation status could be
significant. The preferred position is to exclude from the scheme
sites that are already closed.

If the waste sector is covered by the scheme, an appropriate
participation threshold needs to be developed. For the solid waste
sector, a departure from the 25 kt CO2-e per year threshold
proposed for other sectors may be warranted. In contrast to the
treatment of energy-related emissions, sub-threshold waste
facilities will not face a carbon price in any from, either
directly or indirectly. This raises potential competitive
distortions between covered and uncovered sites, particularly in
highly competitive markets. Failure to cover sub-threshold
facilities also introduces the potential for waste to be displaced
from covered to uncovered sites to avoid permit obligations. In
light of these concerns, stakeholders generally supported a
threshold of 10 kt CO2-e per year, or lower, in urban areas, with
highly competitive markets.

However, extending the 10 kt CO2-e per year to non urban areas has
some drawbacks. Small, council-run sites - many of which sit around
a 10 kt threshold - have expressed the view that there is limited
capacity to absorb participation costs as it would involve
increasing rates. However Hyder consulting[31] advised that:

Local government regulations typically permit genuine cost
recovery within rate setting and waste management contracts
are generally flexible enough to allow for any increased
costs to be passed on to councils. ...

... councils can generally pass on any additional waste
management costs to the rate payers after a community
consultation process. In the majority of, if not all, cases
this takes place towards the end of the financial year while
the new rates become effective with the new year.

Key stakeholders from State Governments and local councils noted
that a 10 kt CO2-e/year threshold could discourage consolidation of
the many small landfill sites in rural and regional Australia. As a
result of these concerns, stakeholders preferred the retention of
the 25 kt CO2-e /year threshold for non-competitive markets. The
reduction in coverage associated with this limit is not expected to
be significant.

In all it is estimated that hybrid 25 kt CO2-e/year and 10 kt CO2-
e/year threshold will capture around 200 facilities (assumed to be
operated by 120 companies - see box 2.2). This would imply
compliance costs of around $42 million (start up) and $7 million
(annual ongoing).

The preferred approach is to include the waste sector in the carbon
pollution reduction scheme. While there are additional compliance
costs and some difficulties with sites close to closure, these are
not insurmountable and the advantages of expanded coverage that the
sector offers are judged to outweigh these costs.

The preferred participation thresholds for landfill operators are
25 kt CO2-e/year in non-competitive markets and 10 kt CO2-e/year in
competitive markets. Consistent with broader scheme design, a
25 kt CO2-e/year participation threshold will be retained for all
other waste sector facilities.

Given the problems associated with the coverage of legacy
emissions, one implementation option is to exclude legacy emissions
from the scheme until 2018. After that time, legacy emissions would
be reduced on average by around 45 per cent. This would reduce the
financial impact of legacy emissions and give landfill operators
time to install methane capture technology to minimise their
emissions profile.

Emissions from land use

The Government has indicated that coverage of the Carbon Pollution
Reduction Scheme would be limited to domestic sources and sinks
that count towards Australia's international obligations (see box
3.4 for further detail on international accounting rules).

|Box 3.4: Current international accounting |
|The international accounting rules, as applied under|
|the Kyoto Protocol, are relevant to the design of |
|the scheme because they determine which emissions |
|sources and sinks count towards Australia's |
|international commitments. Importantly, Kyoto |
|Protocol accounting rules for land based emissions |
|are not comprehensive; they cover a limited set of |
|emissions sources and sinks. These sources are as |
|follows: |
|Agriculture emissions (contained within Article 3.1 |
|of the Kyoto Protocol) includes enteric fermentation|
|in livestock, manure management, rice cultivation, |
|agricultural soils, prescribed burning of savannas, |
|and field burning of agricultural residues. |
|Emissions from land use change and forestry (Article|
|3.3 of the Kyoto Protocol) which includes net |
|emissions from forests established since 1990 on |
|land that was clear of forests on 31 December 1989, |
|and deforestation. |
|Article 3.4 of the Kyoto Protocol provides for |
|additional activities that countries may elect to |
|count toward their emissions target during the first|
|commitment period. These elective activities are: |
|Forest management (plantation forests established |
|before 1990 and all native forests under some form |
|of management) |
|Revegetation (establishment of woody biomass that |
|does not meet forest criteria) |
|Grazing land management (carbon stored in soil and |
|vegetation on grazing land) |
|Cropland management (carbon stored in soil and |
|crops) |
|If a country chooses to include any of the |
|additional activities, it must also include and |
|report on, all emissions from all land nationwide on|
|which those activities are undertaken. Australia has|
|elected not to include these activities because of |
|the high risk that drought or bushfire could result |
|in significant emissions from these sources during |
|the first commitment period. |

Agriculture

Agricultural emissions make up approximately 16 per cent of
Australia's emissions. Agriculture is the dominant source of
methane (primarily from livestock) and nitrous oxide (mainly from
agricultural soils) emissions. The agricultural industry is
dominated by a large number of small businesses. Very few farm
businesses would meet the 25 kt CO2-e/year threshold for reporting
under the NGERS requirements.

As such, the inclusion of agriculture would have significant
benefits. As with other sectors, its inclusion would broaden the
base of the scheme and introduce additional abatement
opportunities. This would reduce the overall costs of achieving a
specified scheme cap under the scheme.

However, there are also a number of difficulties with including
agriculture in the scheme.

The measurement of agricultural emissions is difficult.
Agricultural emissions are highly variable in response to
management practices and climatic conditions. For example, cattle
breeds and feed types in tropical and subtropical regions differ
from those in temperate regions, and have methane conversion rates
that are significantly different. Nitrous oxide emissions from
soils in major cereal-growing regions vary geographically and over
time, according to different rainfall, soil types and fertiliser
application rates. As a result indirect measurement options (using
proxies such as livestock numbers or cropping areas) are imprecise
and may lead to inequitable outcomes.

In addition, the sector includes more than 100,000 entities, many
of which emit less than one kt CO2-e/year. Even if a threshold for
agricultural emissions coverage is applied the number of liable
entities would still be significant. For example, covering about 80
per cent of direct emissions from the beef, sheep, dairy and wheat
industries would require participation in the scheme of around
45,000 farm businesses.

In other areas, such as transport, where there are a large number
of emitters the preferred approach has been to capture these
emissions by placing obligations on upstream (or downstream)
producers. In the case of agriculture this would imply placing
obligations on facilities such as abattoirs and fertiliser
suppliers. However, such an approach would be difficult because:

. there would still be a significant number of responsible
entities who would have to participate in the scheme; and

. the difficulties in indirect measurement mean that
indirect coverage of emissions is likely to be inaccurate
and potentially inequitable.

The Government's preferred position as outlined in the Green Paper
was that agriculture would not be included in the scheme from
commencement but that a decision as to whether agriculture would be
covered in 2015 would be made in 2013.

Agriculture stakeholders generally agreed with the Government's
assessment that coverage of agriculture emissions will not be
possible from scheme commencement. Many stakeholders argued for the
adoption of complementary measures (for example, financial
incentives for adoption of best management practices) to encourage
emissions reductions prior to scheme commencement or as alternative
to coverage over the longer term. However, stakeholders outside the
agriculture sector supported inclusion of the agriculture sector at
the soonest opportunity noting that this will reduce the overall
costs of achieving Australia's mitigation targets and hence the
burden on other sectors of the economy.

Agriculture stakeholders were generally of the view that current
international accounting rules did not present an accurate picture
of emissions from land-use. For example, the National Farmers
Federation argued that:

international greenhouse accounting rules for the land-based
sectors do not appropriately acknowledge the full
sequestration function of agricultural production systems.
These accounting rules do reflect Australia's obligation
under the Kyoto Protocol but are not appropriate for the
longer term goals of Australia's CPRS and are adding to
misleading interpretations of agriculture's contribution to
global warming.

Stakeholders encouraged the Government to negotiate changes to
international rules or to implement a domestic scheme that is not
consistent with the Kyoto Protocol but instead based on optimal
accounting rules.

The Government will continue to work towards international
accounting rules that are scientifically based and suited to
Australia's particular circumstances. However, coverage of
agriculture emissions will not be contingent on achieving an
optimal international accounting framework. The outcome of
international negotiations can not be predicted.

Overall, the preferred position is that agriculture not be included
in the scheme from commencement. Current measurement difficulties
and the large number of potentially liable entities mean that the
compliance costs associated with the inclusion of agriculture would
be substantial and are likely to outweigh the benefits associated
of expanded coverage. To support a final decision on the potential
coverage of agriculture, the Government will work with industry to
identify cost effective points of obligation in the supply chain,
the scope for incorporating direct farm level management of
emissions and necessary improvements in emissions estimation
methods and development of efficient administrative systems.

Reforestation

Reforestation would differ from other covered activities because it
will often provide a net carbon sink. Therefore, whereas other
covered entities would be required to surrender permits for their
emissions, forest landholders are likely to receive permits for
increases in net sequestration.

The inclusion of reforestation provides additional opportunities
for abatement measures within the scheme. This would reduce the
overall costs of abatement and would reduce the burden imposed on
other sectors by the scheme.

The compliance costs associated with the inclusion of forestry
would depend on how the sector was included. (There are no current
reporting obligations for the forestry industry, so all scheme
obligations would be 'new'.) There are two options for including
reforestation:

. mandatory coverage

. voluntary 'opt in'.

The mandatory coverage option would entail significant compliance
costs. It would cover all entities managing forests and would
require a large number of small forest holders to meet scheme
obligations. In many cases these entities would have small holdings
with limited carbon captured or emitted. As a result, mandatory
inclusion would entail significant compliance costs and in some
cases these costs could outweigh any potential benefit from
inclusion in the scheme.

When considering reforestation, a voluntary 'opt in' arrangement is
preferred because scheme participation would not be beneficial for
all. Benefits of scheme participation are likely to be determined
by expected future carbon price, forest management regime and
scheme design details including compliance costs. Forest owners who
opt in to the scheme will consider these factors when deciding
whether to opt in to the scheme.

In determining scheme design, there is scope to reduce compliance
costs, for example, by tailoring reporting and crediting
requirements.

In other sectors, scheme liabilities are calculated based on a
liable entity's annual emissions report. Forest owners could also
be required to report annually. However, forests are likely to be
net carbon sinks, and therefore eligible to receive permits rather
than required to surrender permits. For this reason, it may be
possible to implement alternative, less onerous reporting
arrangements.

To minimise costs for growers, and ensure that changes in forest
sequestration are adequately reported, forest growers will be
required to provide sequestration reports at the end of each
commitment period or at least once every five years, which ever
comes sooner. As permits will only be issued following receipt of a
sequestration report the Government will also allow forest growers
to elect to report more frequently but no more than once a year.
Forest growers would also be required to report on any significant
management or disturbance events that might change projected forest
sequestration.

In implementing the scheme, there is a risk that if the government
provides 'full annual crediting'[32] of permits for all net
increases in greenhouse gases stored in the forest, forest owners
will incur significant liabilities when they harvest the forest or
if it is destroyed by fire (as they will have to surrender permits
to cover the emissions from the forest). In extreme cases this may
lead liable entities to default on their surrender obligations and
the Government would become liable for the emission resulting from
the loss of the forest. As a result, in implementing the scheme it
is proposed to use an 'average crediting' system where growers will
receive a maximum number of permits which is equal to the long term
average increase in net greenhouse gas removals (taking into
account the risk of fire). Under most circumstances, growers will
not be required to surrender permits unless they permanently retire
the forest (that is, use the land for an alternative purpose).

In general, forest industry stakeholders supported the Government's
proposed approach to reforestation but have some concerns in
relation to the design detail of coverage - many stakeholders
expressed misgivings about the complexity and project-level
accuracy of the current National Carbon Accounting Toolbox (NCAT)
for estimating emissions and removals. Other stakeholders
suggested that the NCAT did not accurately reflect the carbon
sequestered in certain forest types, for example biodiverse
plantings. The Government will continue to update NCAT's user
interface and will develop protocols outlining the procedures for
incorporating external data into NCAT where this information can be
verified as accurate.

Submissions from the agricultural industries expressed concern
about the potential implications of coverage of reforestation for
land and water use. Agriculture industries were particularly
concerned that the scheme could provide an incentive for an
increase in managed investment scheme forestry, affect water
availability, or provide incentives for the conversion of prime
agricultural land to forestry.

Allowing entities to accrue carbon permits for reforestation will
provide an incentive for land use change. In some cases this would
be at the expense of existing industries (predominantly
agriculture). In other cases, it may make use of degraded or more
marginal lands. In some cases, the forest may also provide
environmental benefits other than carbon sequestration, for
example, reduced salinity and soil erosion or assisting
biodiversity conservation. Increased forestry activity may also
have implications for water use as forests typically use more water
than other land uses. This may be accounted for if forest owners
are required to purchase the water intercepted by plantations (that
is purchase the water that would otherwise have flowed to
downstream users). From a community wide perspective it is
difficult to assess whether these land and water use impacts, when
taken together, are positive or negative.

Submissions from some conservation groups expressed concern that
the inclusion of reforestation but not deforestation in the scheme
could lead to increased deforestation. Conservation groups believe
this could occur if forest growers have the incentive to maintain
forests planted after 1990 for carbon purposes rather than harvest
them. Under this scenario, demand for wood products would be met by
increased harvesting of native forests. In many Australian States
the management of native forests is regulated by Regional Forest
Agreements (RFAs) which are twenty year plans for the conservation
and sustainable management of Australia's native forests. In
addition, forests that are eligible for the scheme may be subject
to contractual or tax arrangements that require their harvest. The
Government considers that these factors are likely to limit any
increase in deforestation as a result of coverage of reforestation.

Overall, the preferred approach is to include forestry in the
scheme on an 'opt in' basis.

In implementing this position, rules will be needed to ensure that
forest owners are likely to be able to meet their long term permit
obligations. Forest owners are likely to build up a long term
liability in terms of carbon permits that would need to be
surrendered if the forest was converted to an alternative non-
forest land use. The Government will limit scheme participation to
entities that have met accreditation criteria and include under the
scheme a range of enforcement provision to ensure that forest
owners meet these obligations.

Deforestation

Deforestation accounts for a significant (though declining) portion
of Australia's greenhouse gas emissions. In 2006 it accounted for
around 11 per cent of Australia's emissions.

As such, including deforestation would significantly expand
coverage of the Carbon Pollution Reduction Scheme, provide cost
effective abatement options and reduce the overall costs of
achieving any given scheme cap.

However, there would also be a number of costs:

. The areas cleared annually on individual landholdings
range from less than one hectare to thousands of hectares.
Depending on the thresholds for inclusion in the scheme,
covering deforestation could create thousands of
potentially liable entities and there are no obvious
points of obligation elsewhere in the supply chain.

. The need for thresholds to contain scheme costs would mean
that a significant proportion of deforestation would not
be covered.

. Monitoring, reporting and compliance arrangements would be
complicated by the periodic nature of deforestation.
Unlike emissions from industrial facilities, the timing of
emissions from deforestation is difficult to predict.

. Announcing plans to include emissions from deforestation
in the scheme would also create powerful incentives for
pre-emptive land clearing (where allowed under state and
territory regulations) in order to avoid a future
obligation. This could have a range of negative
environmental consequences, as well as increasing
emissions in the Kyoto Protocol period.

It is also important to note that there are a number of state
restrictions on the clearing of 'remnant' or mature forests which
have reduced, and are likely to continue to reduce, emissions from
deforestation.

Some conservation groups advocated the inclusion of deforestation
in the scheme. Conservation groups also advocated the strengthening
of existing state land clearing legislation and other complementary
measures such as incentive based approaches or structural
adjustment programs to achieve further emission reductions from the
sector. Many of these stakeholders noted that accounting for the
land use sector was incomplete and suggested that forest management
including forest degradation be recognised in the scheme. For
instance, the Australian Conservation Foundation recommended that:

Australia moves to a system of full carbon accounting for
all forestry as soon as possible. The polluter pays
principle should apply to all forestry and deforestation
emissions. This could be applied through the payment of a
carbon tax or through coverage under the CPRS once
accounting is sufficient.

The Humane Society International advocated the inclusion of
deforestation on a voluntary opt in basis. However, the
administration arrangements for deforestation are likely to be
significantly more complex than for reforestation.

The circumstances in which landholders are able to obtain a land
clearing permit vary from state to state. Such an approach could
create perverse incentives for landowners to apply for land
clearing permits when they would not otherwise have done so.
Further, some land managers may have only a conditional right to
clear land in limited circumstances. Conditional rights could not
be recognised for the purpose of crediting avoided deforestation.

While there are considerable benefits from the inclusion of
deforestation in the scheme, there are also considerable costs. On
balance, the risks of excessive deforestation prior to the scheme
and the difficulties associated with administering the scheme in
relation to deforestation are judged to outweigh the benefits. The
preferred approach is that emissions from deforestation would not
be included in the Carbon Pollution Reduction Scheme.

Offsets

The scheme could allow non-covered entities to undertake projects
that would reduce emissions from 'business as usual' levels and
grant permits for this abatement (that is to offset emissions in
covered sectors). Allowing offsets would create incentives to
reduce emissions from uncovered activities, and lower carbon costs
within the scheme by giving liable entities access to a broader
range of abatement opportunities.

Offsets can only come from emissions sources that are outside the
scheme. The very broad sectoral coverage proposed for the scheme
means that there is inherently less scope to pursue offset
activities. Nevertheless some emission sources are likely to remain
outside the scheme, for example, deforestation and savanna burning.
In addition some emissions sources such as agriculture are unlikely
to be included in the scheme from commencement.

Some stakeholders considered that offsets should be allowed in the
scheme, for example, from soil carbon, biochar and deforestation.
The difficulty with allowing offsets within the scheme is that they
are inherently complex to establish and administer. The regulator
must be sure that additional abatement has occurred (that would not
have occurred in the absence of the offset scheme) and the
abatement is permanent. As a result offset schemes have high
compliance and administration costs.

Moreover, if agriculture is included in the scheme in the medium
term future, there would be little time for an offset scheme for
this sector to be established and deliver abatement prior to
inclusion in the scheme. As a result it is the preferred position
that the offsets would not be included in the scheme from
commencement. This position would be reviewed following final
decisions on the inclusion of agriculture.

4) Reporting and compliance

Integral to introducing an emissions trading scheme is the
measurement of emissions for each liable emitter. These
measurements form the basis of reporting to the regulator and the
eventual surrender of permits to cover emissions. For many
emitters, the requirement to measure emissions will not be new. As
discussed in chapter 3, emitters in most sectors already have the
obligation to report emissions under the National Greenhouse and
Energy Reporting System (NGERS).

The Government will also have to ensure compliance with reporting
requirements. The operation of the emissions trading scheme will be
new to all market operators and the need to surrender permits will
impose significant costs on many emitters. This may present motive
and opportunities for either violation or inadvertent breeches of
scheme requirements.

Existing NGERS requirements

A logical starting place when considering the most appropriate
reporting requirements is to consider the existing obligations on
business. Under NGERS, liable entities are responsible for
reporting their total emissions of the six key greenhouse gases
each year. The scheme was established to provide a national
framework for reporting of emissions (prior to NGERS a number of
different schemes required the reporting of emissions). It was also
intended to form the basis for reporting under an emissions trading
scheme and provides detailed information to help support
Australia's emissions reporting under the Kyoto Protocol.

The NGERS reporting requirements apply to all facilities that cause
emissions of greenhouse gases that have a CO2-e of 25 kt or more
per year. As discussed in chapter 3, this covers the majority of
emitters who will be caught under the emissions trading scheme. The
additional compliance costs for those entities which are not
required to report under NGERS are outlined in chapter 2 and
detailed in Attachment B.

Under NGERS, the majority of emitters have the choice of four
different methods for estimating emissions (see box 4.1). These
include the National Greenhouse Accounts default method (Method 1)
and higher order methods, (Methods 2-4). In moving through the
methods from one to four, generally the estimation techniques
become more accurate but also more expensive to comply with. That
said, even the simplest method (Method 1) provides estimates using
national averages and ensures accuracy at a nation-wide level.

|Box 4.1: Classes of methodologies available for |
|NGERS |
|Method 1: the National Greenhouse Accounts default |
|method |
|Method 1 provides a class of estimation procedures |
|derived directly from the methodologies used by the |
|Department of Climate Change when preparing the |
|National Greenhouse Accounts. The use of |
|methodologies from the National Accounts anchors |
|Method 1 within the international guidelines adopted|
|by the United Nations Framework Convention on |
|Climate Change for the estimation of greenhouse |
|emissions. |
|Method 1 specifies the use of designated emission |
|factors in the estimation of emissions. These |
|emission factors are national average factors |
|determined by the Department of Climate Change using|
|the Australian Greenhouse Emissions Information |
|System. For example the actual emissions content of |
|coal will vary across facilities and locations, but |
|a national average emissions factor is provided. |
|Method 2: a facility-specific method using industry|
|sampling and listed Australian or international |
|standards or equivalent for analysing fuels and raw |
|materials |
|Method 2 enables entities to undertake additional |
|measurements - for example, the qualities of fuels |
|consumed at a particular facility - in order to gain|
|more accurate estimates for emissions for that |
|particular facility. This method draws on the large |
|body of Australian and international documentary |
|standards prepared by standards organisations to |
|provide benchmarks for procedures for analysing the |
|properties of fuels being combusted. |
|Method 3: a facility-specific method using |
|Australian or international standards or equivalent |
|for sampling and analysing fuels and raw materials |
|Method 3 is very similar to Method 2, except that it|
|requires reporters to comply with Australian or |
|equivalent documentary standards for sampling of |
|fuels or raw materials (as opposed to simply |
|measuring) and documentary standards for analysing |
|fuels. |
|Method 4: direct monitoring of emission systems, on|
|either a continuous or periodic basis |
|Method 4 provides for a different approach to the |
|estimation of emissions. Rather than analysing the |
|chemical properties of inputs (or, in some cases, |
|products), Method 4 aims to directly monitor |
|greenhouse emissions arising from an activity. This |
|approach can provide a higher level of accuracy |
|depending on the type of emission process, however |
|it is more data-intensive than other approaches. |
|As for Methods 2 and 3, a substantial body of |
|documented procedures on monitoring practices and |
|state and territory government regulatory experience|
|provides the principal source of guidance for the |
|establishment of the system proposed under Method 4.|

Options

There are two feasible options for establishing reporting
requirements under the emissions trading scheme. The first is use
the reporting requirements as set out under NGERS including the
default Method 1 and higher order methods in specific
circumstances. The second is to modify these requirements in areas
where more detailed reporting is already current practice.

The first option would be the simplest to administer. It would give
greatest flexibility to business and would minimise compliance
costs - it would impose no new compliance costs on those captured
by NGERS and would involve the minimum necessary compliance costs
for those new to reporting.

In terms of accuracy, it does have some draw backs. It is likely
that estimated emissions will depend to some extent on the method
used to estimate emissions. This may lead some companies to choose
the method of estimation that reports the lowest level of
emissions. This could result in overall underestimation of
emissions if only those who have lower reported emissions under the
more accurate methods (methods 2 to 4) choose these options. This
is not considered to be a significant problem as the more specific
measurement methods are likely to be more costly to implement and
these compliance costs would reduce the incentive to 'shop' amongst
methods. Moreover, the difference in likely reported emissions
between methods is unlikely to be significant for most emitters.

Nevertheless, there is scope to require the more accurate methods
where these are already in common use in the industry (option 2).
Requiring emitters to use the more accurate methods is desirable as
it ensures each facility faces carbon costs that most accurately
represent their specific emissions profile. In addition to fairness
arguments, this is likely to reveal more abatement opportunities as
operators will have a more detailed understanding of a facility's
emissions. Clearly, requiring more detailed measurement by all
industries would impose significant compliance costs. Nevertheless,
in some industries it is common practice to use the higher order
methodologies. Three such industries have been identified:

. As a result of NGERS and the Federal Government's
Generator Efficiency Standards program requirements, it is
widespread practice in the electricity generation sector
for large emitters to use one of the higher order methods
(Methods 2 to 4)

. It is widespread business practice for perfluorocarbon
emissions from aluminium producers to be estimated using
site specific methodologies

. Underground coal mines are required to monitor emissions
using higher order methods to meet state safety
regulations.

Requiring these industries to use higher order estimation methods
would impose minimal additional compliance costs and would ensure
that future reporting continues to be accurate at a facility
specific level.

Stakeholders provided limited comment in response to the Green
Paper on the choice of measurement options. Stakeholders that did
comment on these options generally supported using NGERS as a
starting point and recognised the benefits to the scheme of
pursuing staged increases in the facility level accuracy of
emissions reports (including Exxon Mobil and ESAA)

The preferred approach is to use the NGERS reporting requirements
except for the specified industries where more specific methods are
common practice.

Implementation of the NGERS approach

Following the introduction of the emission trading scheme the
regulator would monitor reporting practices (and choices of
methods) of different industries. The intention would be to move
industries to higher order methods as these become common business
practice. A key consideration in these decisions would be the
minimisation of compliance costs for reporting entities.

International standards change from time to time reflecting
improvements in measurement methodologies and technological
changes. The regulator will also have to monitor changes in
international measurement standards and ensure that Australian
standards reflect these changes. Applying these changes in the
Australian context will require working closely with industry to
ensure that adequate warning of impending changes and appropriate
industry understanding of the new methodologies.

It is also likely that the implementation of the reporting
requirements will require rules to prevent repeated switching
between methodologies. While switching is desirable to allow
emitters to choose their method of reporting, repeated switching
could give rise to differences in reported emissions that do not
reflect differences in underlying emissions. Moreover, businesses
may alter their method from year to year to adopt whichever method
is likely to give them the lower reported emissions in that year.
This would not be in keeping with the intention of giving choice
(to minimise compliance costs) and would create instability (and
potentially underreporting) in total reported emissions. Therefore
where an entity has elected to use Method 2 or above, for a
particular source, that methodology would be the minimum standard
for that entity for a period of four years. The scheme regulator
may grant exceptions to this rule in some circumstances.

Documentation and record keeping requirements for emitters would be
as required by the NGERS scheme with an amendment to the NGERS
legislation so that the requirement to keep records is for five
years. Reporting obligations would also be as set out under NGERS -
emitters would report emissions using the Government's Online
System for Comprehensive Activity Reporting (OSCAR) by 31 October
each year. The Government will also consider the need to move
reporting of emissions to more frequently than on an annual basis
following the commencement of the scheme.

Ensuring compliance with reporting requirements.

Under the proposed reporting requirements liable entities will
report on their own emissions. As they will also have to acquire
(buy) permits to cover these emissions, they will have an incentive
to underreport their emissions. There is also the risk that errors
would be made in reporting either through negligence or through
other 'good faith' mistakes. Errors in the reporting of emissions
would have a number of negative consequences.

It is to be expected that most (intentional) misreporting would
result in an underestimation of emissions and less permits being
surrendered to Government. This would have implications for the
accuracy of national emissions estimates and would represent an
effective loosening of the cap.

Errors in reporting would also have significant implications for
the credibility of the scheme. If there was a perception of
widespread non-compliance, community support for the scheme would
be much harder to maintain (in the absence of community acceptance
and support, the long term future of the scheme could be called
into question). At an international level, confidence in the
legitimacy of the emissions reductions driven by the scheme is a
key consideration in whether other countries will be willing to
'link' with the Australian scheme. International linking is an
important element in reducing the overall costs of the scheme and
the ability to establish future links with international schemes is
an important consideration in the design of the Australian
scheme.[33] Finally, business perceptions of compliance by other
businesses with the scheme could have implications for their own
compliance. That is, if one emitter believes that other emitters
are non-compliant with the scheme, this may influence their
compliance decisions. In closing, it is important to note that, in
considering impacts on the credibility of the scheme, perceptions
of non-compliance can be more important than the actual level of
non-compliance.[34]

Misreporting of emissions would also have a number of implications
at a firm or industry level. The emitter that underreported
emissions would be placed at a competitive advantage vis a vis
other market participants (as they would need to surrender fewer
permits). This advantageous position would be a result of non-
compliance with the law rather than legitimate business practices
and could entail significant costs for competing entities.

For these reasons, assurance arrangements to certify the accuracy
of emissions reporting are required. Three options exist:

. ex-post audits undertaken the Government

. ex-ante audits undertaken by third party auditors

. a hybrid option involving third party audits for very
large emitters (those emitting over 125 kt CO2-e/year) and
Government assurance for liable emitters below this
threshold.

The first option would be similar to the general taxation
arrangements. Business would submit their emissions reports and the
regulator would then undertake audits in a random (or targeted)
manner. The second option would be similar to the arrangements for
the preparation of financial statements under the Corporations Act
2001. Reporting entities would be required to appoint an
independent third party to audit emissions reports before they are
submitted to Government.

Under the second and third options it is expected that (at least
initially) most audits would be undertaken by large accounting and
consulting firms. The extent to which specific training and
qualifications will be required before a person can undertake these
audits is currently the subject of a detailed consultation paper
released by the Department of Climate Change on external auditing
of emissions information. The Government will consider industry
views about relevant skills and expertise, and compliance costs in
finalising policy positions on this level of detail. Over time,
smaller specialist firms may provide these services at lower cost
than the large accounting and consulting firms.

There are two main costs associated with ensuring the accuracy of
emissions reports - compliance costs incurred by business in
seeking third party audits and administration costs associated with
Government activities to ensure the accuracy of reports.

For those businesses that are required to obtain third party
audits, the cost is estimated to be $150 000 per year. It is also
likely that companies would incur some costs associated with
liaising with the auditors. On average these are estimated to be
around $11 500 per business per year. Obviously the overall
compliance costs would be largest under option 2 - all business
would be required to obtain audits. Assuming there are around 1000
liable entities, this would entail total aggregate compliance cost
of around $164 million per year.[35] The third option would only
require around 200 businesses to seek third party audits. The total
compliance costs of this option are estimated to be around $33
million per year. The compliance costs associated with the first
option are minimal.

In terms of administrative costs, it is estimated that the cost to
Government of the third (hybrid) option would be around $5 to $9
million per year. This represents the costs to Government of
undertaking audits of a selection of emissions reports submitted by
liable entities both to double check the reports of vary large
emitters and assure the accuracy of reports by smaller liable
entities. The administrative costs of the first two options have
not been separately estimated, but these costs would be
significantly higher under the first option (reflecting the fact
that no auditing had been undertaken by companies and the
government would need to undertake a significant number of audits
to obtain an acceptable level of confidence that the emissions
reports were accurate) and significantly lower for the second
option (reflecting the fact that all companies had already been
independently audited).

Overall, it is expected that the first option (no third party
audits) would be the least costly option while the second option
(third party audits for all liable entities) would be the most
expensive.

The benefits of assuring emissions reports are essentially the
flipside of the costs of inaccurate reporting detailed above. That
is, ensuring that emissions reports by liable entities are accurate
will improve the accuracy of national emissions estimates, provide
additional confidence in the scheme and minimise any business
distortions created by the misreporting of emissions. While these
benefits are not quantifiable, it is expected that the options
involving third party auditing would offer greater benefits. Third
party auditing would assure the accuracy of each report (where as
Government auditing would only consider a subset of reports)
ensuring the accuracy of overall emissions estimates. Third party
auditing is also more easily observed by relevant stakeholders
(than ex-post Government assurance) ensuring the confidence in the
accuracy of reports is maintained.

The benefits associated with the third (hybrid) option are lower
than under the full third party assurance option as only a subset
of emissions reports are assured. However, the benefits are not
likely to be significantly lower. The majority of emissions are
accounted for by very large emitters (over the 125 kt CO2-e/year
threshold). As a result, assuring the accuracy of these emissions
will ensure that overall emissions data are largely correct.
Moreover, the very large emitters are likely to be the most
'visible' and ensuring the accuracy of these reports should provide
confidence in the accuracy of emissions data for the majority of
stakeholders. Any concerns with the accuracy of reports by smaller
emitters can be alleviated (to a degree) by additional assurance
activities undertaken by the regulator.

Submissions generally supported the need for a strong framework to
assure the quality of emission reporting submitted under the scheme
(Chevron). However, a number of stakeholders did not agree that
assurance of emissions reports should be conducted by independent
third parties prior to submission to the Government under the
scheme. For example, both the Energy Supply Association of
Australia and the Australian Petroleum Production & Exploration
Association argued that a self assurance model would minimise
compliance costs for liable entities.

On balance, it is considered that the hybrid option represents the
best balance of risks to scheme credibility and compliance costs
for reporting entities and is the preferred option. While it is
more costly than the first option (Government audits), it is
considered that mandatory third party auditing is essential to
ensure confidence in the scheme. The second option would provide
some additional benefits, however these are likely to be limited
and this option would be substantially more costly.

In implementing this position the regulator will monitor the
reports of all emitters and will have the power to review and amend
assessments of emissions for up to four years after the date of
assessment (if reports are found to be erroneous). This time period
is broadly consistent with amendment periods under current business
tax provisions for entities with complex affairs. In addition, the
regulator will have the power to impose administrative penalties,
and seek civil and criminal penalties, in the event that emitters
are non compliant with the law.

If there are concerns about the accuracy of reports for reporting
entities with emissions less than 125 kt CO2-e/year, the regulator
would consider the need to extend auditing requirements (this
decision would be taken by Government).

5) Linking the scheme to international markets

Climate change, by its nature is a global problem where the
location of abatement does not affect its contribution to
addressing the problem.

An international carbon market already exists under the Kyoto
Protocol to the United National Framework Convention on Climate
Change[36], and some other countries have developed, or are
developing, domestic emissions trading schemes (see below).

Opportunities for linking are likely to increase substantially over
time, as more countries take on binding emissions constraints and
seek to use domestic emissions trading schemes to achieve their
targets at least cost.

The existence of other international schemes provides opportunities
for Australia to 'link' with these schemes. Linking involves
importing units from other schemes and /or exporting units from
Australia. The key question is how and under what circumstances
Australia should link its scheme with international markets and the
schemes of other countries.

Current international arrangements

The Kyoto Protocol establishes a framework for emissions trading.
The Protocol sets out limits on emissions from each developed
country and countries with economies in transition for the 2008-12
period (the 'first commitment period').

The Kyoto Protocol also provides a framework for parties to acquire
Kyoto units from other countries and count them towards their
emissions targets via different mechanisms (emissions trading, the
'clean development mechanism' and 'joint implementation' projects).
Each mechanism produces a different type of compliance unit (worth
one tonne of CO2-e) that may be traded amongst countries (these are
discussed in more detail below).

All of these units are eligible compliance units under the Kyoto
Protocol; that is, each can be used to offset one tonne of CO2-e
from any party's emissions. As such, each type of compliance unit
could be accepted for compliance in the scheme, linking the
Australian emissions trading scheme to the international market.

One major advantage of linking via the flexibility mechanisms is
that the international architecture ensures the credibility of the
units traded. By linking with the flexibility mechanisms many of
the benefits of directly linking to other domestic and regional
schemes can be achieved as these scheme's are also linked to the
flexibility mechanisms.

It should be noted that the first commitment period of the Kyoto
framework will end in 2012. At this stage it is not certain what
arrangements will be introduced for the post-2012 period as these
are the subject of current international negotiations. As such, it
is important that some flexibility remains over future linking
arrangements so that they can reflect developments in the
international architecture.

Domestic emissions trading schemes are at various stages of
development. Most countries implementing or developing emissions
trading are parties to the Kyoto Protocol. The European Union has
had a successful emissions trading scheme operating since 2005.
Norway also has an emission trading scheme that is linked to the
European scheme. The New Zealand Parliament passed legislation
enacting their emissions trading scheme this year. Following the
change of government in New Zealand, its scheme is under review,
however the new Government remains committed to a modified
emissions trading scheme. Proposals are also at various stages of
development in Canada, the Untied States, Japan, South Korea and
Switzerland.

Where Australia links directly to the scheme of another country
with a Kyoto target, any trades between the scheme could be counted
towards meeting Australia's Kyoto target. As such, the detailed
design of the specific domestic scheme is less relevant as the
trade is backed by the credibility of the Protocol.

Criteria

Determinations on all design elements of the scheme, including
linking, have been made with reference to the standard scheme
criteria. In relation to linking arrangements there are several
criteria of particular importance:

. Environmental integrity: the integrity of the units of
trade (that each unit actually represents an additional
tonne of abatement) is important. Also, since stabilising
global emissions at a safe level will require widespread,
sustained and significant international action, linking
options can also be assessed by their impact on
Australia's ability to shape global solutions to the
challenges posed by climate change.

. Economic efficiency: linking will have implications for
domestic scheme compliance costs, the credibility and
predictability of the scheme, and promotion of least cost
reductions in emissions.

. Minimising implementation risk: a complex scheme design
poses greater risks to the scheme's smooth commencement.
Linking arrangements will have implications for the
simplicity of the scheme. It is desirable that the scheme
avoids design parameters that could lead to erratic and
unpredictable pricing behaviour. The transition to the
scheme will be easier if prices are able to rise gradually
over time. In particular, erratic and unpredictable prices
could have implications for the ongoing credibility of the
scheme. Also, strong opposition to specific elements of
the linking design may lead to the delay in, or difficulty
with, implementation of the scheme more generally.

. Policy flexibility: it is desirable that linking
arrangements allow the scheme design to respond to changes
in international obligations and arrangements.

. Promoting international objectives: linking arrangements
should be consistent with Australia's international
objectives, including any internationally agreed emissions
reduction obligations.

The merits of linking

The first benefit of linking relates to the cost-effectiveness of
emissions reductions and the economic efficiency criterion. An
effective global market with a credible global constraint on
emissions and unlimited linking between countries would reduce
global and Australian abatement costs by ensuring that the cheapest
abatement opportunities are pursued first, regardless of where they
occur.

For example, if the cost of domestic abatement were greater than
abatement in other countries, it would be cheaper for Australian
businesses to purchase permits from international markets than to
abate themselves. This option would not be open to Australian
businesses under a closed scheme (they would have to purchase
permits from the domestic market at higher cost).

In a world with an effective global market, for Australia to
achieve its emissions reduction targets solely through domestic
abatement (that is in a closed scheme with no linking) would be
more costly and would deliver no additional environmental gain.

The second distinct advantage of linking is that it can encourage
the development of global carbon markets. As Garnaut and many
stakeholders recognise, the promotion of emissions trading as a
mechanism is advantageous for global mitigation and therefore
assists Australia to promote its international objectives.

While there are significant benefits from linking there may also be
some drawbacks.

Linking the Australian scheme to international markets means that
the price of Australian permits will be set by international supply
and demand conditions instead of domestic supply and demand
conditions. International carbon prices could fluctuate largely as
a result of political decisions by other Governments and Australia
would have no control over those decisions. In particular, the
current significant uncertainty about future international
arrangements could lead to substantial price uncertainty and
volatility. This uncertainty and volatility could impose
significant costs on businesses who have to make long term
investment decisions, the profitability of which would depend on
the international carbon price. The uncertainty about future
international arrangements is unlikely to be fully resolved before
the commencement of the scheme and may pose difficulties in
managing a smooth transition in the early years of the scheme.

It may be desirable to have a higher degree of domestic abatement
to ensure the ongoing credibility and acceptability of the scheme.
There is a view amongst some stakeholders, particularly
conservation groups, that the scheme should encourage domestic
action and not rely heavily on imported permits.

Overall, international linking would be a positive addition to the
scheme, however, careful consideration needs to be given to
different linking opportunities.

Options

In broad terms, links with other schemes can be described as
either:

. direct, where units from scheme A can be used for
compliance purposes in scheme B; or

. indirect, where schemes A and B have no direct links but
both accept units from scheme C, creating an indirect
pricing link between them.

In addition, links can be either:

. unilateral (one way), where units from system A can be
used in system B, but not vice versa; or

. bilateral (two way), where Governments responsible for
schemes A and B agree to accept units from each other's
schemes.

Within these broad types of linking options, the Government would
need to make choices about:

. the types of international units that might be accepted
for compliance in Australia

. whether any restrictions should apply to how many
international units could be accepted for compliance in
Australia

. whether Australian permits could be transferred outside
Australia and, if so, how many.

The types of international units that might be accepted for
compliance in Australia

There are two categories of international units that could be
considered for compliance in the scheme:

. international Kyoto units or

. international non-Kyoto units.

To be consistent with the environmental integrity criterion, it
would be important that the scheme recognise only units from
schemes that are robust and credible.

Another key consideration, relating to the promoting international
objectives criterion, is whether the use of international units
should be restricted to those that can be counted towards
Australia's national target under the Kyoto Protocol, or whether
other units should be allowed.

International units that cannot be counted towards Australia's
national target are referred to as non-Kyoto units. Possible
sources of non-Kyoto units include those generated in the US,
voluntary market credits, and those from abatement not currently
recognised under the Clean Development Mechanism, such as avoided
deforestation. While allowing for the use of robust non-Kyoto units
for compliance would widen the field of available abatement options
and potentially lower compliance costs, it would increase the cost
to Australia of meeting its international obligations, since those
units would not count towards Australia's Kyoto target. As such the
preferred approach is that non-Kyoto units would not be recognised
for compliance purposes in the scheme, however, this position would
be reviewed for the post-2012-13 period in the light of future
development in the international architecture.

International Kyoto units are established by the Kyoto Protocol
framework and can be used towards meeting Australia's Kyoto target.
As noted above, there are three flexibility mechanisms built into
the Kyoto protocol: emissions trading, the Clean Development
Mechanism and joint implementation projects. These generate four
different Kyoto units, each of which could be accepted in the
context of the Australian scheme as meeting emissions liabilities.
The merits of accepting each of these units is discussed below.

Assigned amount units

Assigned amount units (AAUs) are the primary compliance units under
the Kyoto Protocol, and are issued to countries in line with their
agreed national emissions targets. For example, Australia agreed to
cap emissions at 108 percent of 1990 levels over the Kyoto
compliance period and has therefore been issued with AAUs to cover
these emissions.

Consistent with the economic efficiency criterion, acceptance of
AAUs is likely to provide liable entities with a low cost
compliance option, lowering the overall cost of meeting the
Government's abatement targets.

However, there are some disadvantages to the acceptance of AAUs for
compliance in the scheme:

. Some stakeholders have raised concerns about the
environmental credibility of some AAUs, specifically those
that relate to so-called 'hot air' or surplus AAUs
allocated to those countries whose economies have
contracted since 1990. Those concerns centre on the
argument that use of these AAUs in Australia would not
necessarily mean that emissions would be reduced elsewhere
(that is, they would not represent genuine abatement).
Acceptance of AAUs in the scheme is likely of raise
significant opposition from some stakeholders.

. Given the current uncertainty about the future
international framework, it is not clear how the supply of
AAUs will develop. The volume of surplus AAUs is
potentially large compared to the expected compliance
shortfall for Kyoto parties in the first commitment
period. The World Bank estimates that the compliance
shortfall for Kyoto parties in the first commitment period
could be 3.3 billion tonnes CO2-e, after taking account of
domestic sinks. AAUs have the potential to deliver some
7.1 billion tonnes CO2-e.21 This potential oversupply
would have implications for the global price (although
this will depend on the number of AAUs banked for use in
future periods). If Australia recognised AAUs for
compliance in the scheme this price uncertainty would have
implications for scheme stability.

Given the potential risks to the credibility and stability of the
scheme the preferred approach is not to accept AAUs for compliance
in the scheme. This position would be reviewed in the light of
international developments.

Emissions reduction units

Emissions reduction units (ERUs) are generated via joint
implementation projects where one country implements a project to
reduce emissions in another country (both countries must have a
target under the Kyoto Protocol).

ERUs would offer a low-cost compliance option for liable entities,
promoting a cost-effective way for the scheme to help meet
Australia's emissions targets. Also trade in ERUs represent trade
within the aggregate emissions constraint imposed by the Kyoto
Protocol and could be considered more effective than trade in
international offset credits from uncapped sources.

Overall, there are no significant risks associated with the
recognition of ERUs in the scheme so the preferred approach would
be to recognise these units.

Removal units

Removal units (RMUs) are units issued by another Kyoto party on the
basis of land use, land-use change and forestry. Few countries are
likely to be in a position to generate RMUs, so the potential for
trade in RMUs is likely to be limited. No concerns have been raised
about the use of RMUs, and preferred approach is that RMUs be
recognised as compliance units in Australia's scheme.

Certified emission reductions

Certified emission reductions (CERs) accrue from joint projects
between Kyoto parties with an obligation (developed countries) and
developing countries under the Clean Development Mechanism.
Essentially, the developed country can implement a project in the
developing country and obtain CERs which they can use towards their
Kyoto target.

The Clean Development Mechanism is designed to provide emissions
reductions that can be used by Kyoto parties with an obligation to
meet their commitments under the Protocol as well as support
sustainable development in the host country. It is an offset
mechanism that generates CERs based on differences between an
estimated baseline (expected 'business as usual' emissions) and
actual emissions.

The Clean Development Mechanism has induced significant abatement
activities in developing countries and provides an important source
of low cost abatement opportunities. Trade in CERs is an important
component of the current international market, adding to overall
liquidity.

In addition, the Clean Development Mechanism provides an important
transition mechanism that engages developing countries in
mitigation projects until they are able to take on binding
commitments.

However, some stakeholders have raised concerns about the
environmental credibility of the clean development mechanism, as it
entails no limit on emissions in developing countries. Further,
although the mechanism uses rigorous verification procedures, any
assessment of whether abatement is truly 'additional' entails a
significant degree of judgment.

It should also be noted that different rules apply to afforestation
or reforestation activities in developing countries. These projects
are assessed to have a limited life - less than two commitment
periods for some projects and between 20 and 60 years for longer
term projects - before they need to be replaced. If these CERs were
recognised in Australia's scheme, the Government would need to
replace them with other units when they expired. Acceptance in the
scheme would introduce a contingent liability on Australia under
the Kyoto framework and would have high administrative costs
associated with measures to address the contingent liability.

The preferred approach is that CERs be recognised in the emission
trading scheme. This would not extend to CERs for afforestation and
reforestation projects which have associated contingent obligations
and high administrative costs.

Restrictions on how many international units can be accepted for
compliance

Having decided what types of international units will be accepted
another key consideration is whether the scheme should have any
restrictions on the number of international units that can be used
for compliance.

The chief advantage of not limiting the number of Kyoto units that
can be used for compliance is that domestic compliance costs would
be minimised - liable entities would purchase such units only if
these units were less expensive than domestic compliance options.
This is consistent with the economic efficiency criterion. Allowing
unlimited access to international units would mean that the
international price would act as a useful 'safety valve' on
domestic compliance costs. Imposing limits on access to
international units means that the domestic price for permits could
deviate from the international carbon price. Unlimited access to
international units would also inject greater liquidity into the
Australian market.

However, there are also potential disadvantages associated with
access to an unlimited number of international units including:

. the requirement under the Kyoto Protocol framework for the
use of flexibility mechanisms to be supplemental to
domestic action (referred to as the supplementarity
principle)

. the potential implementation risks associated with
exposing the domestic scheme to the current uncertainty
about future international arrangements that could lead to
significant uncertainty and volatility in the
international price

. the potential desirability of having a higher degree of
domestic abatement to ensure the ongoing credibility and
acceptability of the scheme.

There is no requirement under the Kyoto Protocol to quantify
supplementarity. Also Australia is projected to meet its Kyoto
target on the basis of existing domestic policy mitigation measures
and other ongoing measures such as the Mandatory Renewable Energy
Target and energy efficiency measures which will ensure that an
adequate level of abatement is achieved domestically regardless of
the design of the scheme.

Domestic abatement will occur under the scheme even with unlimited
access to international units. The scheme will reduce emissions in
Australia by introducing a price on carbon. Where the price is
above zero, emissions will be reduced compared with what they would
otherwise have been. With unlimited access to international units
the domestic price for carbon will converge with the international
price. It is expected that the international price will remain
above zero. This means that all domestic abatement that is cost
effective at that price will occur.

Economic modelling by the Treasury suggests that even with
completely open access to international units after 2020, the
scheme will drive significant reductions in Australia's domestic
emissions from what they would otherwise have been. For example, in
the Carbon Pollution Reduction Scheme -5 scenario, Australia's
domestic emissions are projected to be twenty-five per cent lower
than the reference scenario in 2020, and sixty per cent below the
reference scenario in 2050.

In regards to concerns associated with exposing the domestic market
to the potential uncertainty and volatility in the international
market, analysis undertaken by consultants Booz & Co of expected
supply and demand conditions in the international market indicates
that, while significant uncertainty remains there is a reasonably
well functioning and forward looking international market with the
capacity to deal with this uncertainty. Following consultation with
stakeholders, there does not seem to be widespread concern about
the implications of potential price volatility in international
markets.

Recognising the benefits of unlimited access to international units
in ensuring liable entities have access to low cost abatement
opportunities and in providing a 'safety valve' for domestic
prices, the preferred approach is to not limit the number of
international units that can be used for compliance in the scheme.

Transferring Australian permits outside of Australia

Transferring Australian permits to other countries would reduce the
number of permits in Australia's scheme, increasing the Australian
permit price and resulting in relatively more abatement occurring
in Australia than would otherwise be the case. The capacity to sell
and transfer domestic abatement to international markets would also
create new markets for providers of domestic abatement. It would
increase the inflow of foreign capital, providing a stimulus for
domestic abatement activities and investment in low-emissions
technologies, and contribute to reducing the costs of global
mitigation and to increasing global liquidity. The ability to sell
Australian permits into foreign markets is, therefore, generally
desirable.

However, some short-term factors need to be taken into account,
particularly in minimising implementation risk. Adding
international demand to the domestic scheme has the potential to
increase upward pressure on the domestic price of Australian
permits. This poses risks to the stability of domestic prices and,
as a consequence, compliance costs, during the period in which the
scheme is being bedded down. Allowing for the sale and transfer of
Australian permits could also add complexity to the scheme. Neither
of these impacts are desirable while market participants are
adjusting to the scheme's introduction.

Additionally, the Government would need to comply with the
commitment period reserve of the Kyoto Protocol. That requirement
would mean that the Government could not allow for the unlimited
transfer of Australia's Kyoto units to international markets, and
that the commitment period reserve would need to be managed.

The preferred approach is to not allow the transfer of Australian
permits outside of Australia in the initial years of the scheme.

Consultation

The majority of stakeholders consulted are supportive of linking,
noting that it is a cost-effective way of meeting Australia's
emissions reduction targets and that linking can encourage the
development of global carbon markets. Some stakeholders argue
against linking because they would prefer that Australia meet its
national emissions targets from domestic action alone.

Most stakeholders are supportive of linking to the Kyoto Protocol's
flexibility mechanisms. However, some stakeholders question the
credibility of some Kyoto units, particularly CERs.

Many stakeholders are not supportive of a quantitative restriction
and argue that a least cost approach would be to have unlimited use
of credible international units and that this would provide a
valuable 'safety valve' on the permit price in the Australia
scheme. Those that do not support unlimited access to international
units have a preference for domestic abatement.

Some stakeholders would support a quantitative restriction to
comply with international obligations or to ensure scheme
credibility but consider that in general the price should dictate
the extent of use, and as such, restrictions should be set very
high.

In response to the strong stakeholder preference for unlimited
access to international units, the Government has changed its
preferred approach from that which was indicated in the Green Paper
and is now proposing not to have any quantitative restrictions.

In regards to the types of international units that would be
recognised for compliance in the scheme, most stakeholders are
supportive of the preferred approach. A small number of
stakeholders - primarily environmental non-government organisations
including Greenpeace, Friends of the Earth and the Australian
Conservation Foundation - urge the government to narrow the scope
of CERs permissible in the scheme, requesting that only 'gold
standard' credits from the Clean Development Mechanism be accepted.

The majority of submissions accepted the restriction on non Kyoto
units for compliance purposes but urge the Government to push for
recognition of reducing emissions from deforestation and
degradation (REDD) credits in any international agreement in the
post 2012 period.

The decision not to allow the export of Australian units was
recognised as sensible but potentially ineffectual due to the
unlimited banking of permits that the scheme proposes to allow. In
recognition of the potential upward price potential which may
result from the market pricing in expectations of the future value
of export, the Government has decided to delay a decision to allow
for export to a point some years after the scheme has commenced
operation.

Several of the submissions called for the provision of certainty as
soon as possible and as far in about the future as possible on the
qualitative restrictions that will be placed on the import of Kyoto
units. Generally it was requested that changes to linking rules
also be subject to the 'five-year rolling rule' (that is, five
years notice should be given by Government of changes in linking
arrangements). In accordance with these views, the Government will
provide five years' notice on elements of linking policy that are
key determinants of price.

There was overwhelming support for a continued effort to develop
more direct bilateral or regional links in the future, particularly
with New Zealand, Papua New Guinea and Indonesia. New Zealand has
legislation in place for its emissions trading scheme although as
noted above, the new government is reviewing the scheme. Neither
Papua New Guinea nor Indonesia have proposals to develop emissions
trading schemes presently. As Garnaut notes however (Garnaut
Climate Change Review, p. 340), both 'have large opportunities to
reduce land-use change and forestry emissions and to quickly
replace coal (Indonesia) and petroleum with low-emissions fuels'.

Future arrangements

Choices about the nature and extent of linking are likely to change
over time. Obviously, a key event influencing further decisions on
international linking is the development of future international
agreements. Linking arrangements will be subject to review in the
light of ongoing international negotiations and market
developments, with a clear preference for relaxing restriction on
linking with credible schemes and mechanisms as the Australian
scheme matures. Only those linking opportunities that are
consistent with the scheme's objective would be considered. This
would include consistency with Australia's international
obligations.

There are potentially significant benefits associated with deeper
and more expansive linking in the longer term. The Government could
consider establishing a bilateral link with a scheme of another
country by recognising the unit of the other scheme for compliance
purposes and vice versa. Australia may wish to establish a
bilateral link with the scheme of another country to increase the
pool of abatement opportunities for liable entities, to enhance
liquidity and to build international cooperation around emissions
trading. For example, a link between the Australian scheme and the
New Zealand scheme would reduce compliance costs for trans-Tasman
businesses and also offer potential opportunities for sharing
governance arrangements and technical resources (for example,
auditors and accreditation resources).

In order to provide guidance to market participants about potential
future links it is desirable to specify the characteristic of
acceptable links.

Future bilateral links should only be with schemes that are of a
suitable standard, including having:

. an internationally acceptable (or where applicable a
mutually acceptable) level of mitigation commitment

. adequate and comparable monitoring, reporting,
verification, compliance and enforcement mechanisms

. compatibility in design and market rules.

These characteristics would help to ensure future linking
arrangements are consistent with the scheme's overall objective.

It is also desirable for market participants to have a degree of
certainty about future linking arrangements, consistent with
retaining enough flexibility to respond to changing international
arrangements. It is proposed that, the Government will provide at
least five years' notification of a change to linking arrangements
including the establishment of a new bilateral link, except where:

. an independent review, including stakeholder consultation,
finds that establishing a bilateral link with another
country will not have a significant impact on the permit
price in the scheme; and

. the responsible minister decides to waive or shorten the
notice period.

In addition, if Australia were to link with another country's
scheme, it would also indirectly link to all other schemes to which
that scheme is already linked. Therefore it would be desirable that
in making an assessment on whether to link the Government took into
account any existing links of the other scheme.

6) Auctioning of Carbon Pollution Permits

Once created, carbon pollution permits within the scheme cap need
to be allocated or released to the market either by allocating them
to liable entities or by auctioning them. As discussed below,
auctioning is an efficient method of allocating permits. However,
auctioning such a large number of permits raises important issues
of auction design.

The objectives of the auction

The design of the auction will be influenced by the objectives it
is seeking to achieve. The key objectives are as follows:

. Promote allocative efficiency - Permits are channelled to
their highest value in the economy with a minimum of risk
and transaction costs.

. Promote efficient price discovery - Making the auction
results public will provide an important price signal
early in the scheme. Providing a price signal has a
significant role in stimulating behavioural change; for
instance in helping entities manage their emissions
obligations and make investment decisions. This discovery
process is reinforced when the results of early auctions
and the prices obtained are communicated at the start of
the scheme.

. Raise auction revenue - The auction should also raise
revenue that can be used for other policy objectives, such
as providing assistance to households and businesses.
However, the auction has not been designed with the
primary aim of maximising revenue.

There is usually no conflict between the objectives of promoting
allocative efficiency and price discovery, and raising auction
revenue. If conflict arises, the Government will give priority to
the first two objectives.

To promote allocative efficiency and efficient price discovery a
well-designed auction will include:

. a large competitive field of bidders;

. a simple system that encourages participation;

. a stable set of auction rules that are not subject to
arbitrary or unpredictable changes;

. transparent processes that rapidly reveal price
information; and

. minimal fees, charges and other costs of participation
(although some rules to ensure that bids are credible may
be desirable).

In arriving at final policy positions, the Government has sought to
ensure that the development of a deep and liquid secondary market
is not compromised.

Advantages of auctioning as an allocation method

In releasing permits to the market, the Government has two options:
the auctioning of permits and allocating them directly to emitters.

Auctioning permits has a number of advantages over allocating them
directly to liable entities.

In theory, there should be no difference in efficiency between
auctioning permits and allocating them administratively[37],
because permits could be traded to their highest value use under
either system, even if the initial allocation is inefficient.

In practice, because administrative allocations will be made for
reasons other than pure efficiency, the initial allocation of
permits will not necessarily be made to the users that value them
highest. Firms will be able to trade permits on the secondary
market, but trading costs and information issues mean that this
will not be costless. As a result, additional transaction costs
will be incurred under a direct allocation method to ensure that
permits reach their highest value uses.

Auctioning permits also ensures that the entities who are
responsible for high levels of emissions are the ones that pay for
the environmental costs (the 'polluter pays' principle). It also
raises additional revenue for the Government which can be directed
to different areas (in this case assistance to business and
consumers).

The key disadvantage of auctioning permits is that it may be
slightly more expensive for Government depending on the nature of
the administrative allocation method. However, auctions will be
held on an internet platform to reduce the cost to Government and
participants, and in the context of the scheme auction
establishment, running costs are expected to be low. Even with
direct allocation the Government would incur costs associated with
designing and implementing the allocation approach.

Most stakeholders were in favour of auctioning as the preferred
approach to releasing permits. One issue that arose was the free
allocation of permits as part of assistance packages for strongly
affected industries and emissions intensive trade exposed
industries. Some stakeholders were in favour of auctioning 100 per
cent of permits. These included the Australian Financial Markets
Association and the Garnaut Final Report.[38]

Other stakeholders, such as Visy Australia raised concerns that
full auctioning might not result in an equitable allocation of
permits as some industries will be disproportionately affected by
the introduction of the CPRS.

Some stakeholders were opposed to the distribution of permits by
administrative allocation. They included the Construction,
Forestry, Mining and Energy Union who argued that free allocation
encourages gaming behaviour, leads to windfall profits and weakens
the intended outcomes of the scheme.

The economic efficiency benefits of auctioning (the ability to
channel permits to their highest value uses with lower compliance
costs) make it highly desirable to move progressively towards 100
per cent auctioning of permits over the longer term. However, the
use of permits to provide assistance to industry is an important
element of the proposed assistance packages. As such, some initial
free allocations of permits to emissions intensive industries will
be made.

The preferred position is that allocations will, over the longer
term, progressively move towards 100 per cent auctioning as the
scheme matures, subject to the provision of transitional assistance
for emissions-intensive trade-exposed industries and strongly
affected industries.

The key design features of the auctions under the Carbon Pollution
Reduction Scheme

The Green Paper's detailed proposals on auction design drew heavily
on a report on auction design by Evans and Peck, which was
commissioned by the National Emissions Trading Taskforce. The
Government's final positions on auction design have taken into
account that report, stakeholder submissions, and further expert
advice from Tradeslot Pty Ltd who was commissioned by the
Department of Climate Change to provide expert advice on the design
of auctions.

Auction Frequency

In theory, auctions could be held a number of times each year, for
example weekly, quarterly or annually.

Several stakeholders requested that auctions be held more
frequently than quarterly as proposed in the Green Paper. Stanwell
Corporation Limited, ExxonMobil and Frontier Economics wanted more
frequent auctions with monthly being the most requested.

More frequent auctions will mean smaller auctions. The frequency of
auctions and its impact on the size of the auction will have
implications for:

Reliability of price information - More frequent auctions might
reduce the reliability of the price information used to inform
investment decisions early in the scheme. The price signal should
be as reliable and efficient as possible.

The price should reflect market expectations about the demand and
supply of permits, and the bidding field should be competitive and
representative of the broader market. Smaller and more frequent
auctions could lead to fewer participants and compromise the
accuracy of price information from the auction. To reduce this
risk, the Government will auction some minimum number of permits at
each auction. Peter Cramton, an auction consultant working on
behalf of Tradeslot, recommended that the Government target around
5 per cent of permits to be sold at any one auction as a minimum
auction size required for competitive bidding.

Timeliness of the price signal - More frequent auctions could
improve the timeliness of price signals, which would benefit
businesses making investment decisions.

However, once the secondary market has matured, investors will have
readily observable real time market prices as they do in other
markets.

Absorptive capacity of the market - The frequency and size of
auctions may have implications for the absorptive capacity of the
market (that is, its ability to accommodate large transactions).
Smaller quantities of permits associated with more frequent
auctions are likely to be more readily absorbed by the market.

Administrative costs - More frequent auctions involve a higher
administrative cost for the regulator, and potentially for bidders.
However, the capacity to hold auctions on the internet means that
costs are minimised and unlikely to be an important factor in
determining auction frequency.

Development of the secondary market - Some stakeholders, including
Origin Energy and the Australian Securities Exchange, were
concerned that greater auction frequency might delay the
development of the financial services normally provided by the
secondary market.

Cash flow and working capital management - A number of stakeholders
cited cash flow and working capital management as reasons for
holding more frequent auctions. In particular there were concerns
about working capital related to the timing difference between the
purchase of permits and their surrender to meet scheme obligations.
Many stakeholders were concerned that they would be required to
borrow to purchase permits many months or even years in advance.
Some were concerned that recent financial market uncertainty would
mean that they would not be in a position to borrow the required
funds or would be forced to pay interest rates that they could not
afford.

Most of these stakeholders suggested monthly auctions, on the
grounds that this would enable them to better manage their
liabilities and reduce their working capital or debt financing
costs. For example, TRUenergy argued for monthly auctions with
weekly settlements to minimise the working capital and cash flow
impact on affected energy market participants.

Other stakeholders, such as Caltex, supported weekly auctions
because such auctions would reduce working capital requirements.

Frequent auctions may provide liable entities with an additional
option for managing their obligations under the scheme,
particularly given any working capital or debt financing
constraints they may have. For example, they might want to align
their expenditure on permits with their accruing liability over the
compliance period. This is similar to the way businesses have
developed strategies for managing their accruing tax liabilities.

In the presence of a functioning secondary market, the frequency of
auctions should not affect liability management or the costs of
working capital or debt financing. Permit prices, like prices of
other financial assets, are expected to, on average, yield a return
equal to a market interest rate sufficient to compensate investors
for the risk of holding permits. Because permits do not pay
dividends or interest, like shares or bonds, the return will come
in the form of capital gains. That is, on average, permit values
(prices) would be expected to rise at the market interest rate.

The permit interest rate and permit prices will also reflect
economic conditions and the cost of capital. Lower economic growth
or constraints on credit will reduce demand and cause the carbon
price to be lower and permits to be more affordable for business.
Because of this, the timing and frequency of permit purchases at
auction will have a more limited effect on the current dollar cost
of permits to businesses with similar costs of capital.

Assessment

The scheme design should include frequent permit auctions while
maintaining the size and efficiency of each auction. More frequent,
smaller auctions are more easily absorbed by the market, present a
lower risk in the event of an operational failure of an auction,
and perhaps provide business with more flexibility while the
secondary market is maturing.

However, more frequent, smaller auctions have a number of
disadvantages:

. On average, they will have lower participation. The
auction would then be more prone to manipulation and
erratic pricing outcomes.

. More frequent auctions could reduce the time businesses
devote to information gathering and preparation, reducing
the accuracy of some bids and the auction price signal.

. They may also reduce the level of activity in the
secondary market, especially if auctions are double-sided
(that is, allow liable entities to both buy and sell
permits).

While quarterly auctions could be sufficient, 12 auctions
throughout the financial year will accommodate stakeholder demand
for greater frequency while not unduly risking the efficiency of
the auction process. This is the preferred approach.

Auction settlement arrangements and deferred payment

A number of stakeholders, most notably those from the power
generation sector, such as Loy Yang Power and TRUenergy expressed
concerns over their capacity as individual businesses to manage the
cash-flow costs associated with their significant permit purchase
obligations. They argued that auction participants should be able
to defer payment for permits until the relevant vintage year (for
example, pay for 2013 permits in 2013 even if the permits are
purchased at a 2010 auction).

Other scheme proposals and international experience provide limited
guidance on optimal auction payment arrangements for a carbon
market. The Task Group on Emissions Trading, the National Emissions
Trading Taskforce and the New Zealand Emissions Trading Scheme did
not make any specific recommendations about payment arrangements.
In the European Union Emissions Trading Scheme, because of large-
scale free allocations of permits, liable entities were not
required to buy large parcels at auction, rendering payment terms
irrelevant. Under the Regional Greenhouse Gas Initiative, financial
settlement and transfer of permits to successful bidders occurred
within 14 days of the first auction, although very loose caps under
that scheme have meant very low prices ($3 per tonne of carbon
dioxide equivalent). The Garnaut Final Report recommended against
lengthy deferred payment.

Deferred payment is likely to encourage participation in the
auction of future vintages reducing the risk of low demand or
unreliable prices for future vintages.

However, the provision of deferred payment arrangements has the
potential to expose the Government to financial risk and would be
administratively complex. Government provision of deferred payment
terms may also disrupt the development of the secondary market
needed for longer term risk management by business. This could
occur for example, by Government service provision 'crowding out'
the equivalent service in the private sector. In the absence of
Government provision, demand for these services is likely to be met
by private sector financial intermediaries.

Assessment

It will be important that, if a deferred payment arrangement was
allowed, that all bids made during the auction must represent both
final valuation and capacity to purchase ensuring the credibility
of the auction. This would require the creation of a contract
through the act of bidding, and the imposition of substantive
penalties for buyers who default. Further mitigation strategies
could include not transferring ownership until the permit is paid
for, and implementing extensive credit checks.

There are a range of costs and benefits associated with the
provision of deferred payment arrangements. These merit further
consideration and a decision on whether to adopt deferred payment
processes will be taken in due course.

Advance auctioning of future vintages

The scheme will have annual caps and surrender periods. Consistent
with this approach, permits will also be differentiated by annual
vintages; that is, each permit will pertain to a particular
financial year scheme cap.

|Box 6.1: International and other Australian scheme |
|proposals |
|The expert auction report by Evans and Peck, |
|commissioned by the National Emissions Trading |
|Taskforce, recommended quarterly auctions of current|
|year vintages and auctions of three future year |
|vintages once a year (to be conducted simultaneously|
|with one of the current year auctions). |
|The taskforce proposed auctions of current year and |
|future year vintages.[39] However, it noted 'scope |
|for further work to refine timing and frequency as |
|detailed scheme design progresses' and that, in |
|particular, 'consideration should be given to the |
|different incentives faced by bidders in relation to|
|timing'. The Garnaut Final Report proposed one to |
|two years (spot plus one future vintage), and the |
|Regional Greenhouse Gas Initiative[40] four years |
|(spot plus three future vintages). |
|The European Union Emissions Trading Scheme[41] and |
|the proposed New Zealand Emissions Trading |
|Scheme[42] do not include advance auctions of future|
|vintages. |

Most stakeholders, including the Australian Securities Exchange,
supported the auction of future year vintages as future vintages
may be an alternative to the spot market and any associated
derivative markets for liable entities seeking to manage future
emissions obligations.

Some stakeholders also argued for the issuing of vintages from
distant future periods as a signal of scheme credibility and
longevity. This is similar to the approach proposed in the McKibbin-
Wilcoxen hybrid model for climate change policy, which uses long-
term permits partly to give investors a stake in the longevity and
credibility of the scheme.[43]

Advance auctions of future vintages are not required for carbon
futures prices to emerge. For example, derivative markets have
developed in the European Union Emissions Trading Scheme without
advance auctions. While advance auctions can provide flexibility
for liable entities and contribute to the credibility of the
scheme, they can also increase the complexity of auctions and
reduce the number of permits of particular vintages available at
each auction. Depending on how far in advance vintages are
auctioned, the Government's flexibility to set caps could be
reduced over time. The extent of these disadvantages will depend on
how many future vintages are auctioned.

The key advantage of the advance auction of future vintages is that
advance auctions would give entities trying to manage future
emissions liabilities an alternative to buying up and hoarding the
current year's permits.

Assessment

It is important that the advantages of increasing flexibility and
certainty for liable entities are balanced against the Government's
flexibility to set caps over time. Auctioning a greater number of
future year vintages implies a smaller number available at each
auction. Therefore, the preferred position is that auctions be held
for the current year vintage plus each of the next three financial
year vintages held once each year.

Auction participation

Universal participation would allow non-liable entities, including
financial intermediaries, to participate in auctions.

Some stakeholders opposed this proposal, raising concerns that the
participation of non-liable entities in auctions may result in
speculation and the bidding up of prices. For example, Woodside
Energy Limited argued that in order to ensure market liquidity and
eliminate price risk, the Government should limit participation, at
least initially, and restrict eligibility to register ownership of
permits to firms which are emitters or which have permit surrender
obligations under the scheme.

The Australian Food and Grocery Council also argued that allowing
financial markets to participate in the auctioning process invites
the possibility of manipulation over the carbon trading system,
leaving genuine purchasers of permits at a disadvantage.

However, limiting auction participation would have a number of
disadvantages:

. An auction is more likely to deliver reliable price
signals if the field of bidders is competitive.
Restricting the number of bidders would reduce the
competitiveness of the bidding field and increase the
scope for market manipulation.

. Smaller liable entities might prefer to use specialist
financial intermediaries to help them manage their
emissions obligations over the year, rather than directly
participating in auctions. It would also give liable
entities an unfair advantage in the secondary market over
others who seek to provide such services.

. In practical terms, it would be difficult to limit
participation and enforce a restricted auction scheme, as
excluded entities could simply contract with liable
entities to buy permits on their behalf.

. For liable entities to be able to manage their carbon cost
price risks, they are likely to want to enter into hedging
contracts. Not allowing other players, including financial
market participants, to buy permits at auction is likely
to slow the development of such hedging products, which
would have the perverse outcome of making price risk less
manageable.

However, to ensure that auctions are competitive and free of
manipulation, it is envisaged that steps will be taken to ensure
that bidders are credible. Those measures may include some form of
financial guarantee or cash deposit to ensure that bidders will be
able to pay for the permits they buy at auction, and to encourage
only genuine participants. Depending on the number of permits a
bidder acquires and the price at which they are acquired, either
the deposit would be returned or the bidder's payment would be
reduced.

A further way to limit market manipulation is limit the maximum
number of permits that can be purchased at any one auction. The
Government plans to limit the maximum parcel of permits that can be
purchased at any one auction to 25 per cent of the available
amount.[44]

Overall, while some stakeholders opposed universal participation in
auctions, there are significant benefits to opening up auctions to
all parties and this is the preferred position.

Implementation

There are also a number of smaller implementation decisions that
the Government meeds to make. It is also envisaged that
implementing these decisions will result in an auction design with
a number of attributes. These are outlined in box 6.1

The timing of the first auction

The first auction could be held, in theory, at any time before the
start of the scheme or after the scheme has commenced.

Some permits could be auctioned in advance of the start of the
scheme to provide early carbon price signals to businesses,
enabling them to make more informed investment decisions. An early
auction would also help to prompt the development of an active
secondary market.

However, some practical considerations limit how early the first
auction could occur.

The legislation establishing the scheme must have commenced before
the first auction takes place. The current timeline suggests that
this will not be until the second half of 2009. The national
registry will also need to be completed before the first auction of
permits, to enable permits to be held in accounts in the registry.

For the auction to generate reliable price signals, the first
auction should occur after participants have been able to develop
informed opinions about overall demand and supply conditions. In
practice, this means that they would need to know the scheme cap
(the supply of permits). Final announcements about the cap will not
be made until early 2010.

Many liable entities will be required to monitor and report their
emissions for the year ended 30 June 2009 under the National
Greenhouse and Energy Reporting Act 2007. Once it is made public,
that information will be useful for liable entities and financial
market analysts in assessing value in the market. The first
greenhouse and energy reports must be lodged in October 2009. This
implies that the first auction could be held in early 2010. This
will give the carbon market three to six months of trading time
before the first compliance period begins.

Stakeholders that commented generally supported the Government's
proposal to hold the first auction in early 2010, prior to the
commencement of the scheme. However a few recommended an earlier
start, for instance Origin Energy supported:

... an auction as early as practicable before the scheme
commences. Ideally, the first auction should take place in
the second half of 2009.

While earlier auctions would have benefits, the practical
considerations discussed above mean that an earlier auction is
unlikely to be feasible and the preferred position is that the
first auction take place as early as is feasible in 2010, before
the start of the scheme.

Auction Type

Over time, the secondary market will provide a range of services
that better facilitate trading and risk management. However, such
services might be limited in the short term, which may effect the
efficient operation of the secondary market. Therefore, the
Government has a role in providing some transitional auction
services to reduce this implementation risk.

The following auction features will facilitate and encourage the
participation of liable entities in the early years of the scheme,
as familiarity with and confidence in the new environment develops.

Ascending clock

In an ascending clock auction, the auctioneer announces the current
price. Bidders indicate the number of permits they are prepared to
purchase at that price. If demand exceeds supply, the auctioneer
raises the price in the next round and bidders resubmit their bids.
This process continues until the number offered is equal to or
greater than demand. Bidders then pay the price from the previous
bid round.

Ascending clock auctions can also allow proxy bidding, in which
bidders submit in advance their demand schedule for permits at
various prices. These bidders would not need to participate further
in the auction. This enables bidders to submit bids, as would be
done under a sealed bid system, if this is more convenient (see
below).

The ascending clock auction also provides information on the
aggregate demand schedule at the end of the auction, which promotes
efficient price discovery in the secondary market.

The Government initially favoured ascending clock auctions for a
number of reasons, including their transparency of operation, and
because they allow small players to 'free ride' on the information
sets of larger players. With sealed bids, small players have no
access to market information during bidding and could miss out on
an allocation because of strategic bidding by larger operators.

However, to accommodate some stakeholders' desire for simplicity,
the Government will allow 'proxy bidding', as described above.
Proxy bidding will replicate some of the advantages of a sealed bid
auction, even where the auction type is simultaneous ascending
clock.

Auction governance arrangements

Once established, the scheme regulator will be best placed to
manage ongoing auction policy design and operational matters, with
wide discretion prescribed in the legislative framework. This will
result in an administratively more efficient outcome than requiring
the responsible minister to approve small changes to auction
design.

Auction rules will require different arrangements at the start of
the scheme. This is particularly so because the scheme regulator
might not be established in time to develop and consult on a
detailed auction strategy before the first auction is held. Until
the auction arrangements are established, operational flexibility
within clearly specified objectives is desirable, because the
auction design is likely to need to be fine tuned over time.

The Government has experience in auctioning other forms of
property, such as the auction process for Treasury Bonds and has
taken the governance arrangements operating in those markets into
account in finalising its auction governance arrangements.

Auction design decisions and operational rules will be made public.

Consistent with the preferred position in the Green Paper, the
minister will make a disallowable legislative instrument
determining the auction process and operational rules during
calendar years 2010 and 2011. After that time, the regulator will
have the power to make such an instrument. In both cases, the
primary objectives will be to promote the efficient allocation and
price discovery of permits. This arrangement will provide certainty
for business.

|Box 6.2: Features of the auction |
|Uniform pricing |
|The ultimate price paid per permit will be identical|
|for all successful bidders, regardless of their |
|respective valuations. This is a natural outcome of |
|the ascending clock system, and one that does not |
|discriminate between bidders. |
|Aggregate demand revealed each round |
|At the end of every auction round, the auctioneer |
|will provide information on the number of permits |
|demanded by participants at the current price. To |
|avoid collusion, individual bids will not be |
|published. |
|Proxy bidding |
|Proxy bidding allows bidders to delegate actions to |
|the auctioneer by submitting a set of bidding rules.|
|Bidders can submit their permit demand schedules and|
|then receive the amount specified at the final |
|auction price. Proxy bidding in sealed bid format |
|will not interfere with the operation, transparency |
|or efficiency of the ascending clock auction; it |
|simply automates bidder preferences. It does not |
|remove the round-by-round disclosure of aggregate |
|demand by the auctioneer. |
|Publication of auction results as soon as feasible |
|The market will be informed of the results of |
|auctions in a timely fashion. As the auction system |
|will be fully automated, results will be released |
|within seven days of each auction. |
|Reserve price |
|The auction will have a reserve price set well below|
|the expected market price. This is in line with |
|arrangements in the United Kingdom under the |
|European Union Emissions Trading Scheme. The reserve|
|price will increase efficiency by limiting the abuse|
|of market power or collusion by entities, and |
|accelerating the auction process. It is an |
|administrative mechanism aimed at improving the |
|speed and efficiency of the auction and is not |
|intended as a price floor in the market. Unsold |
|permits will need to be sold at future auctions. |
|Internet auction platform |
|Auctions will be conducted using an internet |
|platform. The internet platform will encourage more |
|entrants and greater competition because it is low |
|cost and readily accessible. |

7) Setting scheme caps

The scheme cap determines the number of domestic carbon pollution
permits (permits) that will be issued by the Government. Allowable
emissions across the sectors covered by the scheme will only be
able to exceed the cap if this is matched by the surrender of
eligible international units[45], additional permits issued as a
result of forestry activities or the destruction of synthetic
greenhouse gases, additional permits issued under the price cap
mechanism or, possibly, scheme offsets.

In a system with little or no international linkage, the
interaction between the cap and the demand for permits is the
primary determinant of the carbon price: the more stringent the
scheme cap, the higher the price, all other things being equal.
However, the Government has decided to allow unlimited imports of
eligible international units from scheme commencement and to review
the scope for exporting permits over time.

If the international price is below the domestic price, this will
create an incentive for liable entities to import cheaper eligible
international units for use in acquitting their liabilities under
the scheme. This is expected to reduce the demand for permits and
decrease domestic prices causing these to converge on the
international price which in turn will be determined by global
abatement demand and supply conditions. In this instance, the
domestic scheme cap will no longer be a significant determinant of
domestic carbon prices.

If the international price is above the domestic price there will
be no incentive for liable entities to import eligible
international units. In this instance, the domestic scheme cap will
remain a key determinant of domestic prices until such time as the
restriction on exports is lifted or the international price falls
below the domestic price.

As there is uncertainty over relative international prices and
future international linking policy, guidance over scheme policy
including scheme cap setting will be required to inform business
investment.

The key driver of cost to the Australian economy will be the
ambitiousness of the national targets that are agreed
internationally. The scheme cap will simply be set in accordance
with these national targets. The precise level of scheme caps is
not discussed in this chapter.

Guidance over scheme caps

There are four key questions that must be addressed in regard to
the guidance over scheme caps:

. Should announced scheme caps be adjusted in light of
international developments?

. How far into the future should scheme caps be set and
announced and how often should this period be extended?

. What additional guidance should be provided?

. What is the approach for setting scheme caps?

Should announced scheme caps be adjusted in light of international
developments?

Setting scheme caps for a certain period in advance is an exercise
in risk management. There is considerable uncertainty about
international developments after 2012, with little clear direction
on the likely outcome of negotiations. If caps are set five years
in advance, future shifts in the international situation may mean
that the caps are inconsistent with Australia's negotiated
position. The critical question is whether the risk of
inconsistency is borne by participants within the scheme or by tax
payers.

If, following the advance announcement of scheme caps, the
Government were to commit to a national emissions trajectory that
is stricter than that implied by these scheme caps, it would have
two broad options for meeting the national targets.

. The Government could tighten the scheme cap to match the
change in Australia's international commitments. This
could be done by buying back permits, or by reducing the
number of permits that the Government sells at future
auctions. In both cases, a policy of altering the caps
would transfer some of the risk of changes in Australia's
international obligations to participants in the scheme.

. The Government could make up the shortfall on its own
account rather than through the scheme. This could be
achieved by the Government honouring international
agreements through the purchase of eligible international
units without changing the scheme cap. This is the
approach recommended by the Garnaut Final Report.

Alterations to scheme caps after their announcement would be
disruptive to the market because it changes the anticipated supply
of permits, thereby weakening the value of announcing caps in
advance. On the other hand, Government purchases of eligible
international units quarantine the scheme from external shocks and
provide investors and others in the broader economy with certainty
about short-term caps. Further, the Government will take domestic
commitments and objectives into account when negotiating
international commitments and so is in a position to manage risks
over such a time horizon. For this reason, the purchase of eligible
international units by the Government is preferred.

Stakeholders including the Australian Financial Markets Association
and the Australian Chamber of Commerce and Industry were broadly
supportive of the Government making up the difference between
scheme caps and internationally negotiated targets.

However, some stakeholders advocated against the use of eligible
international units to make up the shortfall. For example, the
Hunter Community Environment Centre questions the environmental
efficacy of eligible international units, and the Australian
Network of Environmental Defender's Offices argues this is against
the 'polluter pays' principle.

While standing ready to purchase eligible international units
presents a fiscal risk, this is likely to be small, since it is
proposed that scheme caps extend for only five years (or else to
the end of a known international commitment).

The preferred position is that the scheme cap not be adjusted in
the event that it is incompatible with internationally negotiated
national targets and, if necessary, the Government would make up
any shortfall in internationally agreed targets by purchasing
eligible international units.

How far into the future should scheme caps be set and announced and
how often should this period be extended?

Duration of guidance period over scheme caps

Three broad options were considered for announcement of future
scheme caps:

. A long period of certainty, such as 10 years or more
(recommended by the Task Group on Emissions Trading (TGET)
[46] and the National Emissions Trading Taskforce (NETT)
[47]).

. A medium period of certainty, such as five years
(recommended by The Garnaut Climate Change Review: Final
report).[48]

. The minimum number of years required to align with the
international commitment period. For example, the
Government could provide just two years (2010-11 to 2011-
12) to align with the current Kyoto Protocol commitment
period. New Zealand[49] and the European Union[50] have
aligned scheme caps with their international obligations
in their emissions trading schemes.

|Box 7.1: Duration of scheme caps in international |
|and other Australian scheme proposals |
|The first commitment period under the Kyoto Protocol|
|allowed for a five-year commitment period (2008-12).|
|If the second commitment period were of the same |
|five-year duration, it would run from 2013 to 2017. |
|The United Nations' negotiation for a post-2012 |
|outcome is unlikely to address the length of the |
|second commitment period before late 2009. In part |
|the negotiated length of a second commitment period |
|will depend on the emerging shape of the overall |
|post-2012 package. The higher the level of ambition |
|for developed and developing country commitments, |
|the greater the desirability of locking in |
|commitments over a longer time period. |
|The European Union Emissions Trading Scheme |
|originally announced that scheme caps in Phase I |
|would be set for three years, and for five years in |
|Phase II.[51] It is proposed that in Phase III of |
|the scheme, scheme caps will be set for eight years |
|(2013 to 2020).[52] |
|A survey of European Union Emissions Trading Scheme |
|stakeholders and participants, commissioned by the |
|European Commission as part of its review of the |
|scheme, indicated that uncertainty created by the |
|short initial phase for scheme caps was the biggest |
|obstacle to market liquidity.[53] A large majority |
|of the companies and industry associations surveyed |
|indicated that they would prefer phases of 10 years |
|or more, with national allocation plans being |
|announced two or three years in advance of units |
|being allocated. |
|At the start of the New Zealand Emissions Trading |
|Scheme, scheme caps will be known only for the years|
|to the end of the Kyoto commitment period (2012). It|
|is intended that domestic emissions trading scheme |
|caps after 2012 will coincide with the period set |
|for future international emissions commitments.[54] |
|In Australia, both the National Emissions Trading |
|Taskforce (NETT)[55] and the Task Group on Emissions|
|Trading (TGET)[56] recommended that firm caps be set|
|for a period of 10 years, followed by a 10 year |
|range of caps (called 'gateways'). |
|The Garnaut Final Report has recommended that firm |
|caps be set for five years, and that information on |
|possible longer-term trajectories and a long-term |
|target, which would be specified in advance, is |
|provided.[57] Different trajectories would apply, |
|depending on Australia's international commitments. |
|The Government would announce when the specified |
|conditions for switching tracks had been met five |
|years in advance of the intended switch.[58] |

Several stakeholders argued for a longer period of known caps
including the Australian Financial Markets Association, Origin
Energy and Alcoa. Ten years of certainty over scheme caps (or even
longer as advocated by some stakeholders) would provide a greater
information set with which to inform permit prices. This would help
to guide investment proposals with longer payback periods.

However, Australia's current international commitments have only
been agreed to 2011-12. By extending deep into the future, a 10-
year cap period risks significant misalignment between caps and
further obligations that Australia might choose to negotiate and
accept and may also unduly constrain Australia's negotiating
position.

Although providing certainty to liable parties, fixing scheme caps
independently of Australia's international position for that length
of time exposes the Government to risk that it will be required to
purchase eligible international units to make up any shortfalls
that may result.

A small number of stakeholders advocated much shorter periods of
guidance including the Australian Network of Environmental
Defender's Office, Greenpeace, the Hunter Community Environment
Centre and the Parramatta Climate Action Network.

Minimum certainty over scheme caps would align with the current
Kyoto commitment period, ensuring consistency between the scheme
and Australia's international obligations. However, it would give
only limited guidance to market participants and leave considerable
uncertainty around the likely direction of Government policy.

Therefore, in the absence of clear direction in relation to
international commitments, the Government must choose the minimum
duration of scheme caps it will announce. This decision is finely
balanced, however, five years of scheme caps at scheme commencement
- consistent with the recommendations of the Garnaut Final Report -
appears to strike a reasonable balance between the need for
investment certainty and the need to maintain flexibility in
relation to future international negotiations and commitments.

As a result, the preferred position is that scheme caps be
announced five years in advance. This period may be extended in the
event that the Government enters an international commitment with a
longer duration.

Extensions of the guidance period

Scheme caps will need to be regularly extended in order to maintain
an adequate level of guidance. The National Emissions Trading
Taskforce (NETT) and the Garnaut Final Report proposed that firm
caps be extended by one year, every year, while the TGET
recommended that caps be extended by five years, every five years.

A short interval for extending scheme caps (such as one year) has a
number of advantages. A short interval would increase flexibility
for the Government, which could make small extensions to the cap
each year in response to developments in the economy, environmental
science or international objectives and commitments. A short
interval would help maintain a minimum period of certainty over
caps at all times. It would also provide a more regular flow of
information to the market about future emissions constraints, which
could help promote a more continuous pricing response, rather than
sharp, irregular adjustments.

The disadvantage of extending scheme caps by one year, every year,
is that the administrative costs of gathering advice, consulting
stakeholders and effecting the change through the appropriate
legislative mechanism would be higher than if scheme caps were
extended less regularly.

Stakeholders including BP were broadly supportive of the proposed
(year by year) approach to extending scheme caps.

On balance, it is considered that the need to ensure at least five
years of certainty for business is important, even though this
entails higher costs for Government. As a result the preferred
approach is that scheme caps be extended by one year, each year, as
required to maintain a minimum five-year certainty period.

What additional guidance should be provided??

To further inform the market the Government could also announce
'gateways' (ranges of scheme caps) beyond the five years of scheme
caps. Gateways are essentially a pre commitment by Government to
ensure that the scheme cap at some future point(s) in time will be
in a certain range. That is, for a set period in the future it
offers a range of emissions outputs from which the Government would
choose the scheme cap (see figure 7.1).

Figure 7.1 Scheme gateways

[pic]

The Garnaut Final Report, TGET and NETT all proposed that some form
of gateway be used. Similarly, caps for Phase III of the
EU emissions trading system are currently expressed as a
gateway.[59] In all of these proposals or arrangements, gateways
take the form of a government commitment to a range of values for
future caps.

The principal advantage of using gateways is that it allows the
Government to provide more information to the market about future
caps, but in a way that maintains a degree of flexibility.
Providing information about constraints on future cap-setting would
increase certainty over the path of the scheme cap would travel and
would assist industry in planning new investments.

A second potential advantage is that a gateway could promote
Australia's international climate change objectives by signalling
Australia's readiness to commit to stricter domestic caps in the
event that other countries make similar commitments.

The only major potential disadvantage associated with the use of
gateways is that they might unduly constrain the Government's
flexibility in the event that it wished to set a cap that was
outside the gateway range. However, that risk should be taken into
account when determining the scheme gateways and needs to be
balanced against the benefits of providing greater investor
certainty and more accurate international signalling.

Few stakeholders commented on the use of gateways. Of these
stakeholders most of them (such as the Investor Group on Climate
Change and Transfield) expressed broad support for gateways as
proposed, citing reasons of adequate gateway lengths that provided
additional business certainty. However, a couple of stakeholders
(such as the Australian Conservation Council) argued that gateways
should not be used as they erode the flexibility of Government to
choose significantly tighter scheme caps in the future. Some, such
as Environment Business Australia, expressed preferences for
shorter gateway lengths to reduce the risk to Government. To
address these concerns gateways should be set taking into account
progress in international negotiations.

Other stakeholders, such as the Business Council of Australia,
preferred longer gateways lengths to give additional certainty to
business. With more international linking, the domestic price is
likely to converge on the international price. This will reduce the
price relevance of domestic scheme caps and therefore the
importance of gateway guidance over these. As stakeholders
increasingly understand the importance of international prices,
there will be less focus on gateways as an indicator of
'certainty'.

Nevertheless, in the short to medium term, gateways can provide
useful guidance with limited cost to government. As a result, the
provision of gateways beyond the period of fixed scheme caps is the
preferred approach.

What is the approach for setting scheme caps?

A primary aim of the scheme is to help Australia meet its emissions
reduction targets in the most flexible and cost effective way. The
scheme will reflect this national target through the stringency of
the scheme caps.

Australia's emissions reduction targets are specified in terms of
national emissions. Because the scheme will not cover all sources
of emissions at commencement, the scheme cap and Australia's total
national emissions will be different. Emissions from covered
sources will form only a subset of total national emissions.
Therefore, there needs to be a clear relationship between the
scheme cap and the indicative national emissions trajectory.

Since the gap between the scheme cap and the indicative national
emissions trajectory relates to uncovered emissions, this raises
the question of whether uncovered emissions sources should share in
the national emissions reduction effort and, if so, how.

If sectors cannot be covered, consideration will be given to
alternative mitigation measures. The purpose of such measures would
be to ensure that uncovered sectors make an equivalent contribution
to achieving Australia's national emissions reductions objectives
and have incentives to undertake abatement. Alternative mitigation
measures could include regulatory requirements that entities meet
certain emissions standards, or to adopt low-emissions technologies
or management practices. To ensure an equivalent contribution,
alternative mitigation measures would be designed to deliver
abatement up to a cost that is roughly the same as the carbon price
under the scheme. Decisions on these measures will be taken in due
course.

To ensure that the scheme helps Australia meet its internationally
agreed national targets, and to account for any alternative
mitigation measures applied to the uncovered sectors, the approach
to setting scheme caps will be to subtract from the indicative
national emissions trajectory the projected emissions from sources
not covered under the scheme.

It is possible that this calculation could deliver scheme caps that
lie outside the gateway range (at either the top of the gateway or
the bottom). In that case, the cap would need to be set at the
closest gateway point.

Implementation

As discussed in chapter 11, scheme caps would be established in
regulations (disallowable instruments). As a result delays in
putting in place the regulations extending scheme caps are
possible, and would reduce the certainty period over scheme caps.

To ensure that five scheme caps are always in place in line with
the Government's commitment to medium-term policy certainty, a
default mechanism will be required.

Setting the default equal to some proportion of the previous scheme
cap could be done by formula. As the market would tend to use the
previous scheme cap as a guide, this approach would probably be the
least disruptive to permit prices. Furthermore, such a default
would, on average, have more legitimacy because it would relate to
the parliament's most recent decision rather than a default that
was anchored to, say, a gateway that may have been set up to five
years earlier.

A reduction in emissions could be built into the default, to give
confidence to investors that continued emissions reductions would
be required, even if regulations were not in place. A simple
default cap that declines at one per cent a year will achieve that
outcome.

Timing of initial scheme cap announcements

A number of stakeholders requested that scheme caps be set and
announced as early as possible before scheme commencement, such as
Origin Energy and BP Australia. A 2008 scheme cap announcement
would provide early guidance for investors. However, it is also
critical that the scheme cap decision is made with the most up-to-
date information available, including:

. information about developments in Australia's
international commitments after 2012 (beyond the first
Kyoto commitment period)

. modelling results that take into account more accurate
nearer term data and assumptions about emissions,
complementary policies and economic data

. National Greenhouse and Energy Reporting Act 2007 data for
2008-09 (available to the Government in November 2009).

Cap-setting decisions before 2010 would therefore be premature, and
the costs of errors could be high, since caps, once set, will not
subsequently be adjusted. As a result it is envisaged that
decisions on the initial scheme caps and gateways will be made in
early 2010.

8) Carbon market

The Carbon Pollution Reduction Scheme will establish a market for
greenhouse gas emissions, commonly known as a carbon market. A well-
developed carbon market, including secondary and derivatives
markets, will enable the economy to reduce emissions in a cost-
effective way.[60] The market will provide a reliable price to
inform business investment, enabling entities liable under the
scheme to obtain carbon pollution permits as and when required and
to manage carbon risks.

There are three key questions that must be addressed in regard to
the use of permits:

. Should permits be bankable?

. Should entities be able to 'borrow' permits from future
years?

. Should there be a price cap on permits?

Should permits be bankable?

Banking allows permits to be saved for use in future years. With
unlimited banking, permits would not have an expiry date - once
issued, they could be used for compliance at any future time.

Box 8.1 outlines banking arrangements in international and other
Australian schemes.

|Box 8.1: International and other Australian scheme |
|banking proposals |
|The National Emissions Trading Taskforce[61] and The|
|Garnaut Climate Change Review: Final report[62] |
|recommended unlimited banking. The New Zealand |
|Emissions Trading Scheme also incorporates unlimited|
|banking.[63] However, the Garnaut Final Report noted|
|that, if a transitional price cap is used, permits |
|should not be allowed to be banked between the |
|transition period and the subsequent period. |
|Similarly, the Task Group on Emissions Trading[64] |
|suggested that some limitations on banking might be |
|needed in the early years of the scheme while a |
|transitional price cap is in place. |
|The European Union Emissions Trading Scheme allows |
|banking between years, but not between Phase I and |
|Phase II.[65] However, banking is allowed between |
|Phase II and Phase III.[66] |

There are three broad banking options:

. allowing unlimited banking

. not allowing banking in the early stages of the scheme

. not allowing banking.

A substantial number of stakeholders commented on banking. Of these
the large majority were highly supportive of unlimited banking,
however, some environmental groups argued that banking should not
be allowed as it may lead to emissions targets being breached in
later years. A small number of stakeholders also expressed concerns
that unlimited banking could raise the price of permits at the
start of the scheme.

As with all measures that improve intertemporal flexibility,
allowing banking is likely to improve the economic efficiency of
the scheme. Banking allows participants to set aside permits for
later high demand periods. This advantage is likely to be
significant - the total resource costs of meeting a long-term
emissions constraint are likely to be lower with unlimited banking
than without.

Banking provides greater flexibility both for market participants
and, to some extent, for the Government. A more flexible market
reduces the pressure on the Government to predict the economy's
demand for permits accurately from one year to the next.

Banking provisions will reduce scheme implementation risks. First,
banking is generally likely to lead to an overall price path that
is smoother than the non-banking alternative, promoting efficient
price discovery. Limiting banking in phases can lead to cyclical
pricing behaviour, with prices falling to zero at the end of each
phase, as occurred at the end of Phase I of the European Union
Emissions Trading Scheme (EU ETS).[67]

Second, if banking is not allowed, permits have a 'use it or lose
it' property. Liable entities will be less likely to take early
action to explore abatement potential if previously obtained
permits that become surplus cannot be banked for future use. The
absence of banking could therefore slow the pace of adjustment to
the emissions constraints.

On the other hand, banking might result in higher initial prices
for permits, as noted in some submissions. Setting permits aside
for future use reduces current supply (increasing the current
price), but increases future supply (decreasing the future price).
While this smoothes the price in the long term, the initial price
rise makes it more difficult to engineer an 'easy' start to the
scheme by having relatively low prices.

For this reason, some stakeholders have suggested that banking be
disallowed initially while the economy is adjusting to the carbon
constraint. However, there are a number of arguments against this:

. Any step change in prices would only be deferred to the
period in which banking is allowed.

. Prices in subsequent periods would be higher than they
would have been had banking been allowed, as more
expensive abatement options are pursued (which could have
been avoided if less expensive shorter term abatement had
been pursued).

. Disallowing banking between phases could lead to the
collapse of the price of permits at the end of the non-
banking phase and then a large price step up in the next
phase, as occurred in the EU ETS. This cyclical pricing
behaviour could lead to less efficient market outcomes and
reduce confidence in the system overall.

Current international arrangements allow for banking, that is,
eligible international units can be carried over into the next (as
yet unspecified) commitment period. If future international
arrangements did not allow for banking, there would be a small risk
that banking in the scheme would be inconsistent with Australia's
international emissions reduction target.

Overall, the advantages of banking (reducing overall costs,
encouraging early and efficient abatement activity, providing
greater flexibility to participants and to governments) outweigh
the disadvantages (higher early prices than otherwise, and
potential inconsistency with international obligations).

Finally, the advantages of banking are greatest if banking is
continuous. For these reasons the preferred position is that
unlimited banking of permits will be allowed under the scheme
(except those accessed under the price cap arrangements - see
below).

Should entities be able to 'borrow' permits from future years?

Borrowing allows permits to be brought forward from future years.
Borrowing can be short term (borrowing only from the subsequent
year) or long term (borrowing two or more years in advance).

Box 8.2 outlines international and other Australian scheme
borrowing proposals.

|Box 8.2: International and other Australian scheme |
|proposals for borrowing |
|No Australian proposals or international schemes |
|have recommended unlimited long-term borrowing. |
|In principle, the Garnaut Final Report allowed for |
|some limited long-term borrowing. This was to be |
|administered by the regulator through the official |
|'lending' of permits from future years (but not |
|exceeding five years in advance), with an obligation|
|to repay the loan at a future date. The regulator |
|would lend only amounts that would not destabilise |
|the current or future market. In this way, the |
|regulator would be an 'independent carbon bank' that|
|determines how many permits can be lent, and to |
|whom, based on an assessment of creditworthiness. |
|The European Union Emissions Trading Scheme has a |
|form of unlimited short-term borrowing.[68] |
|Allowances from the following year are issued early |
|and may be used for surrender in the current year. |
|The Regional Clean Air Incentives Market (RECLAIM) |
|scheme in the United States has a form of limited |
|short-term borrowing: half of the following year's |
|units are issued for use in surrender in the current|
|year.[69] |
|The National Emissions Trading Taskforce recommended|
|a more limited form of short-term borrowing: up to |
|1 per cent of a party's obligation could be met by |
|using the following year's vintage permits.[70] |
|The Renewable Energy Target[71], the NSW Greenhouse |
|Gas Reduction Scheme[72] and the Australian Capital |
|Territory Greenhouse Gas Abatement Scheme[73] also |
|have a form of short-term borrowing. Liable entities|
|are allowed a limited shortfall without penalty, as |
|long as the shortfall is made up in the following |
|year. |
|The Task Group on Emissions Trading recommended that|
|there be no provision for borrowing.[74] |

A substantial number of stakeholders commented on borrowing. Of
these most were supportive of short-term limited borrowing,
however, some stakeholders argued that a greater degree of
borrowing should be allowed on the basis that it would provide for
greater flexibility, while others argued that no borrowing should
be allowed as it may compromise the environmental integrity of the
scheme.

Long-term borrowing

The combination of unlimited banking and unlimited long-term
borrowing (borrowing two or more years in advance) would result in
a 'carbon budget' approach. That system would allow a larger
proportion of permits to be used in the short term, with
corresponding reductions in emissions in later years, if that were
the most cost-effective means of remaining within the overall
carbon constraint over time. If the integrity of the carbon budget
could be maintained, this would be the most economically efficient
option.

There are three important disadvantages of unlimited long-term
borrowing. First, in the domestic context, it might lead to
pressure being applied to the Government to subsequently change the
rules. In particular, if too many permits are used in the short
term because firms borrow from the future, the Government might be
pressured into issuing more permits in the future to avoid problems
associated with a subsequent shortage of permits. Industry would
have a large incentive to overuse permits (that is, to do less
abatement than otherwise) in the short term in the knowledge that
the Government may have little option but to accede in the longer
term, or risk damage to the economy. Second, long-term borrowing
arrangements are not accepted in other schemes and may pose
difficulties for linking. Third, if long-term borrowing is allowed
under the international climate change framework, this could lead
to significant and potentially detrimental delays in the global
abatement effort.

Given these risks, the option of unlimited borrowing could
undermine the environmental integrity of the scheme. That risk
would exist even if borrowing were administered by the scheme
regulator in the manner proposed in the Garnaut Final Report.
Furthermore, banking in the early stages of the scheme, in
anticipation of tighter future caps, would create a store of banked
permits that could be used in future years of high demand. That
buffer would allow an economically efficient outcome without the
need for long-term borrowing. This is why unlimited long-term
borrowing is not allowed in any existing scheme and why it is not
the preferred approach.

Short-term borrowing

Short-term borrowing (borrowing one year in advance) would promote
economic efficiency without the same risks as long-term borrowing.
The primary purpose of allowing borrowing between adjacent periods
is to prevent price spikes and resultant economic disruption around
the final surrender date. Although the frequency and timing of
auctions will take into consideration the variation in demand for
permits over the course of the year, the risk of price spikes
around the surrender date remains, by which time actual emissions
for the year and issued permits are fixed. Price spikes can arise
either from 'output surges', arising from natural variation in the
economy, or from speculators 'squeezing' a thin pre-surrender date
market. By increasing the supply of permits, borrowing from
adjacent periods reduces the likelihood of squeezing and gives the
market more capacity to cope with output surges.

Under current international arrangements borrowing is not allowed
between commitment periods. Short-term borrowing in the scheme will
allow for a limited number of future vintage permits to be used in
the current commitment period. Where it is expected that there will
be net borrowing, the Government will need to manage the difference
between scheme design and the international architecture. This
could be achieved by purchasing Kyoto units that can be surrendered
in the first commitment period to account for the additional
emissions associated with borrowed permits. In the second
commitment period, the Government would be able to sell surplus
Kyoto units because emissions in that period will be lower than
they otherwise would have been in the absence of borrowing. This is
primarily a concern in the last year of the commitment period. It
is not likely to be a problem, as net banking in the scheme is
expected over time and it is envisaged that borrowing will be
limited to 5 per cent of the next year's vintage (see below).

The preferred position is that the scheme will permit short-term
borrowing.

Form of borrowing

There are several options for limiting the amount of short-term
borrowing in the scheme. Few stakeholders commented on this issue.

Some options are to limit borrowing by:

. allowing only a certain percentage of a party's obligation
to be met using the following year's vintage of permits
(option 1)

. marking a subset of a year's vintage as available for use
in the previous year's compliance period (option 2)

. having the regulator administer borrowing arrangements
(option 3).

Option 1 and option 2 deliver an equivalent level of borrowing, as
required for output surges. However, option 1 is superior to option
2 in alleviating squeezes (squeezes rely on a shortage of usable
units). Because any of the next year's vintage could be used (in
limited quantities) under option 1, it would be difficult to create
a squeeze in supply, as that would require the acquisition of the
entire year's allocation. Option 1 is also simpler to implement, as
it does not subdivide vintages into different categories.

Option 3 is to have the regulator administer the level of borrowing
in accordance with the needs of the market, as proposed in the
Garnaut Final Report. The regulator would assess the
creditworthiness of the borrower, who would be obliged to repay the
debt by providing permits to the regulator at a later date. While
the Government would be responsible for setting overall banking and
borrowing policy, it would be up to the regulator to decide on the
exact amount, timing and terms of the arrangement.

This arrangement is more administratively complex than the other
options, which require no assessment of creditworthiness and, as
long as the allowance for banking is limited, does not pose a risk
to the credibility of the longer term cap. A discretionary approach
would also be less transparent and would provide the market with
less certainty than one in which rules were legislated. A
discretionary approach also requires a high degree of confidence in
institutional arrangements, which generally takes time to develop
through a track record of sound performance.

For these reasons, the preferred position is to allow liable
entities to discharge a certain percentage of their obligation
using the following year's vintage of permits (option 1).

Quantum of borrowing allowance

Unlimited short-term borrowing, like unlimited long-term borrowing,
may result in credibility risks for the scheme. For this reason,
some limit on short-term borrowing is warranted.

The Green Paper preferred position was to limit the amount of short-
term borrowing to 5 per cent of an entity's obligations. In
relation to determining the limit on borrowing, the Green Paper
noted that there would need to be careful analysis of the natural
fluctuation of emissions in the covered sectors and the allowance
of international units into the domestic scheme.

The limit on short-term borrowing should be enough to provide a
buffer against potential price spikes arising from output surges
(arising from natural variation in the economy) or from financial
market participants squeezing a thin pre-surrender date market.

|Box 8.3: Borrowing and the variability in emissions|
| |
|The limit on short-term borrowing should be |
|sufficient to take account of output surges in the |
|economy. One way to measure output surges is to |
|examine the historic variations in national |
|emissions from sources covered under the scheme. |
|The broken line in Chart 8.1 represents the trend in|
|cumulative emissions growth from covered sectors |
|(from 1990 levels). This can be viewed as the |
|'expected' growth of emissions from the covered |
|sectors of the economy. The solid line represents |
|the actual cumulative emissions growth from covered |
|sectors (from 1990 levels). |
|Figure 8.1: Variability in national emissions |
|[pic] |
|Source: National Greenhouse Gas Inventory, |
|Department of Climate Change. |
|Since 1990, for all covered sectors, emissions have |
|not fluctuated from trend by more than around 2 per |
|cent annually. For borrowing purposes, the relevant |
|years are those in which actual emissions are higher|
|than the trend growth in emissions. This indicates |
|that there has been a surge in the level of |
|emissions (above the level entities may have been |
|expecting), which may leave liable entities with a |
|potential shortfall in permits and require them to |
|borrow from the adjacent period. |

The information in box 8.3 suggests that a borrowing limit of 5 per
cent would provide a more than adequate buffer against output
surges. This limit would also provide some protection against
cornering of the market by providing another source of permits
beyond the current year. Because any of the next year's permits can
be used, all of these would need to be bought up in order to corner
the market.

The cap on borrowing would be in place at the entity level. This
would translate through to the scheme as a whole and represent an
upper bound for the aggregate borrowing allowed under the scheme.

A borrowing limit of 5 per cent should be sufficient to provide a
buffer against output surges and squeezes. This limit achieves
market flexibility and smooths price shocks, while avoiding damage
to the credibility of the medium-term national target.

Should there be a price cap on permits?

A price cap is a mechanism for setting the maximum cost of
compliance under the scheme. In theory, a liable entity would be
prepared to pay up to the cap price for a permit. If the price of
permits rose beyond that point, the entity would access the price
cap rather than buy a permit.

Use of a price cap

An emissions trading scheme controls the quantity of emissions
through the issue of permits and leaves the price to be determined
in the carbon market. (In contrast, a carbon tax would control the
price of emissions and leave the market to determine the quantity.)

The Government cannot control both the price and the quantity of
emissions. The Government controls the supply of permits
(emissions) and, to the extent that it targets a certain price, it
must change the level of supply. In effect, if the Government
targets a particular price, the total quantity of emissions is no
longer set by the scheme cap.

A price cap, then, is a commitment to loosen the scheme cap if the
scheme cap (as currently set) leads to a market price above a
certain predetermined level. This occurs because for every use of
the price cap an equivalent number of permits are no longer
required to be surrendered, effectively increasing the supply of
units.

The purpose of the price cap is to set a maximum cost of compliance
for liable entities by providing them the option of a cash payment
instead of surrendering permits to discharge their liability under
the scheme. While the price cap will present a powerful economic
influence on prices it is not intended to directly place a ceiling
on permit price outcomes in the secondary market or at auction.
Prices in the secondary market and at auction will fluctuate
depending on market conditions and may even exceed the price cap
level from time to time. To allow the smooth operation of the
market, the Government does not intend to intervene to stop these
kinds of temporary price fluctuations. Notwithstanding these
fluctuations liable entities will have certainty over their
ultimate maximum costs of compliance.

Figures 8.2 and 8.3 provide a stylised illustration of the
implications of a price cap in a single period of carbon constraint
without open international linking. Figure 8.2 shows a scenario in
which demand for emissions is relatively low compared to the cap,
so the market clearing price is below the price cap and the
Government takes no action. Figure 8.3 shows a scenario in which
demand for emissions is relatively high compared to the cap, so the
market clearing price is higher than the price cap. In that
scenario, the Government increases the supply until the price is
reduced to the price cap level.

Figure 8.2: Price cap set above market clearing price

[pic]

Figure 8.3: Price cap set below market clearing price

[pic]

The combination of unlimited banking and a price cap also adds an
intertemporal dimension. If liable entities access the price cap
while banking permits for use in future periods, that will create
an inventory of permits with which to increase future emissions.
Because of this feature, a price cap has the potential to loosen
not only the current cap but also future caps.

Box 8.4 outlines some price cap arrangements in Australian and
international schemes and in other scheme proposals.

|Box 8.4: International and other Australian scheme |
|price cap proposals |
|Price caps of various forms have been a feature in |
|several emissions trading schemes and proposals. |
|The National Emissions Trading Taskforce[75] and the|
|Task Group on Emissions Trading[76] recommended that|
|an Australian scheme have a price cap, although both|
|suggested that this arrangement be reviewed over |
|time. The purpose of the price cap was to limit |
|compliance costs and to make them more predictable |
|and stable at the commencement of the scheme. |
|In the proposed United States emissions trading |
|scheme, a recent revision to the Lieberman-Warner |
|Climate Security Act included an 'emergency |
|off-ramp' provision that aims to prevent excessive |
|carbon allowance price rises. |
|In the McKibbin-Wilcoxen model, a price cap in the |
|form of additional issuance is a permanent feature |
|of the scheme design.[77] |
|The current Renewable Energy Target, the New South |
|Wales Greenhouse Gas Reduction Scheme[78], the |
|Australian Capital Territory Greenhouse Gas |
|Abatement Scheme[79] and the Queensland Gas |
|Scheme[80] all have price caps. |
|The Garnaut Final Report did not support the use of |
|a price cap because of the potential implications |
|for environmental integrity, international linking |
|and the potential risk and cost to taxpayers. The |
|report considered the option of a transitional price|
|control (fixing the price) for the period from 2010 |
|to 2012, but expressed a preference for an |
|unconstrained system coupled with the early |
|acceptance of European Union Emissions Trading |
|Scheme allowances. |
|The EU emissions trading scheme does not contain a |
|price cap and uses a combination of a high |
|compliance fee and a make-good provision to ensure |
|that caps are met under all circumstances.[81] |
|The New Zealand Government does not, in principle, |
|support the inclusion of a price cap in the New |
|Zealand Emissions Trading Scheme. However, New |
|Zealand will consider a price cap if its scheme |
|cannot be linked to an international carbon market. |
|This could occur if there is no successor agreement |
|to the Kyoto Protocol or if a suitable international|
|market for emissions is not in place when the New |
|Zealand scheme commences.[82] |

Stakeholders were split over the issue of a price cap, with liable
parties generally for and financial intermediaries and
environmental organisations generally against its use. Those in
favour of a price cap argued that it would reduce upward price
volatility and reduce implementation risk for participants. Those
against the use of a price cap argued that it would undermine the
environmental integrity of the scheme and impede the operation of
the market at prices above the cap.

The main advantage of a price cap is that it reduces upside price
risk for liable parties by capping the cost of compliance under the
scheme. It also makes explicit the Government's policy response in
the event of extreme pricing outcomes in the market. In this
respect, it can help to promote a smoother transition for those
covered by the scheme, and thereby reduce implementation risk.

There are three main disadvantages of a price cap:

. Accessing the price cap would loosen the emissions cap,
reducing the environmental integrity of the scheme. It
might even cause a loosening of future emissions caps,
further undermining environmental integrity. However,
environmental integrity is only seriously compromised if
the price cap is set so low that its use is widespread.
There is no automatic environmental damage associated with
a price cap: the Renewable Energy Target[83] and the New
South Wales Greenhouse Gas Abatement Scheme[84] have price
caps, but have extremely high levels of scheme compliance
through regular surrender of compliance units or
certificates.

. Use of the price cap would increase the likelihood that
Australia would have to purchase eligible international
units to meet its emissions reduction target. This
transfers risks from scheme participants to taxpayers. The
precise cost to taxpayers will be a function of the level
of use of the price cap, the cost of international units,
the impact on auction revenue of relatively reduced scheme
prices, and any timing differences between payment of the
price cap and the purchase of international units. Because
of the potential cost to taxpayers, it is important that
the price cap be set at a level which is likely to result
in the covered sectors meeting their share of the national
effort.

. A price cap may complicate linking decisions, and might
prove to be an impediment to linking with some schemes.

A number of other scheme features also diminish the need for a
price cap. Banking and borrowing are weaker methods of constraining
the cost of compliance. The proposal to allow unlimited imported
international units to be used for compliance in the Australian
scheme may also suppress prices, depending on international
conditions. However, since the international unit price is
uncertain, so too is its value as a precisely known cap on scheme
costs.

While there are risks associated with a price cap, the alternative
is essentially to commit to enforcing compliance at any cost. While
the principle of allowing the market to operate freely is an
important one, an emissions trading scheme is a Government-operated
system, and some price levels may not be credibly sustained. A
price cap can be seen as a way of making explicit the Government's
response should the price of permits rise to a level that imposes a
significant and unacceptable cost on the economy.

The preferred position is that the scheme will have a price cap for
the period from 2010-11 to 2014-15.

Form of price cap

A price cap can take a variety of forms, but the essential element
is that, ultimately, a cash payment in lieu of the surrender of
permits could discharge an obligation accrued under the scheme.

A price cap could take two main forms:

. access to an unlimited store of additional permits, issued
by the Government at a fixed price

. an administrative penalty for non-compliance.

All emissions trading schemes require some form of penalty for non-
compliance. If the penalty is in the form of a cash payment in lieu
of surrendering permits, it will form an effective price cap in the
scheme. Other forms of compliance penalty might not be effective
price caps.

The two forms of price cap have the same basic effect of limiting
scheme compliance costs, although there are some subtle
differences.

. Payment of an administrative penalty would not be tax
deductible under Australian income tax law. Additional
issuance, depending on its legal form, could have
different tax implications at the point of surrender.

. An administrative penalty for non-compliance may encourage
liable entities to pay higher prices for permits and
generate higher levels of compliance within the scheme
caps. Many firms place a high value on their reputation as
good corporate citizens, and will want to be seen to be
complying. Purchase of additional units at a set price
would not have those reputational implications.

Some stakeholders in favour of a price cap were supportive of the
Government issuing more permits in unlimited quantities at a fixed
price. Very few stakeholders favoured the administrative penalty
for non-compliance. There were also a large number of stakeholders
who wanted a combination of the two in the form of a tax-deductible
fee.

A tax-deductible fee and the issuing of additional permits at
surrender date for a fixed price are identical in economic
substance. Both would be identical for tax purposes, represent the
same effective loosening of the scheme cap (as user entities would
emit more than otherwise) and be administratively simple to
operate. However, issuing additional permits is legislatively
simpler to implement and also aligns with the purpose of the price
cap mechanism - to explicitly and transparently cap prices at an
appropriate level determined by the Government. Furthermore, for
reporting purposes, the issuance of permits makes the loosening of
the scheme cap transparent.

The preferred position is that the scheme will have a price cap in
the form of access to an unlimited store of additional permits,
issued by the Government at a fixed price. These permits would not
be able to be traded or banked for future use.

Implementation

The permit will be the basic unit of compliance and trade in the
scheme. It will be designed to provide a high level of legal and
financial certainty.

. Carbon pollution permits will be personal property.

. Each permit can be surrendered to discharge scheme
obligations relating to the emission of one tonne of
carbon dioxide equivalent of greenhouse gas.

. Each permit will be surrendered under the scheme only
once.

. There will be no power in the legislation to involuntarily
extinguish or for a court to order the relinquishment of
permits without compensation, except where the permits
have been obtained through misrepresentation or fraud.

. Permits, other than those issued at a fixed price, will be
transferable.

. Permit holders will be entitled to surrender only permits
that are entered on the national registry. Legal title
will be transferred only by entry in the registry.

. The creation of equitable interests in permits will be
permitted, as will taking security over them.

. Each permit will have a unique identification number and
will be marked with the first year in which it can validly
be surrendered (its 'vintage'). It will not have an expiry
date.

. The permit will be represented by an electronic entry in
the registry, rather than by a paper certificate.

Services provided in relation to permits will be similar to those
for financial products, such as shares and debentures. Those
services are expected to include the provision of trading advice,
brokerage services, trading platforms and support services. It is
expected that derivatives over permits will be financial products
for the purposes of the Corporations Act 2001 as it currently
stands, and there is no proposal to change this.

Permits, like other financial products, could also be the subject
of market misconduct, including market manipulation and insider
trading. Market manipulation includes manipulation of the auction
process (for example, through collusion) and of prices in the
secondary market. There is also the possibility of cornering the
market for permits close to the time for surrender. To address
these risks the Government has decided that permits and Kyoto units
will be regulated as financial products under Chapter 7 of the
Corporations Act 2001 and the Australian Securities and Investments
Commission Act 2001 with appropriate adjustments to fit the
characteristics of permits and avoid unnecessary compliance costs,
and relying on its own constitutional power. They will also be
subject to the economy-wide competition provisions in the Trade
Practices Act 1974.

9) Taxation issues

The introduction of an emissions trading scheme has a number of
implications. Permits to emit carbon will be a valuable instrument
and their acquisition, possession and disposal will create
obligations under the taxation system.

In theory the Government could make no changes and rely on generic
provisions in taxation law to govern any taxation obligations
arising under the emissions trading scheme.

While it is intended that the design of the tax system creates
minimal distortion around permit purchases, uses or sales, in some
cases the generic tax requirements may create incentives to
categorise the purchase or holding of permits in certain ways to
reduce tax liabilities. In some instances, it may create an
incentive to purchase, hold or dispose of permits at a time or in a
way that the business would not otherwise have done but for the
advantageous tax treatment the action would receive.

This chapter of the RIS looks at the treatment of permits under the
current taxation arrangements and whether an amended system would
be an improvement on the generic provisions.

The main objectives are pursued when considering the merits of
different taxation arrangements:

. The taxation arrangements should not distort incentives
surrounding business decisions to acquire, hold or dispose
of emissions permits.

. The taxation arrangements should be as simple as possible,
minimising compliance and administration costs.

. The taxation arrangements should provide business with a
consistent tax treatment.

. The proposed taxation treatment will not impose any
additional compliance costs on consumers.

. The proposed taxation treatment will not place an
unreasonable administrative burden on the Government.

The current taxation arrangements

For a taxpayer carrying on a business or undertaking other
assessable income earning activities, the existing income tax law
would recognise the cost of acquiring permits.

The particular treatment and provisions that would apply in any
particular case would depend on the entity's purpose in holding a
permit, both at the time of purchase and while the permit is held.
For example, an entity could purchase a permit:

. to meet an obligation under the Australian scheme

. as part of its trading portfolio as trading stock

. to surrender voluntarily as part of a marketing campaign

. as an investment.

Application of the current tax law

While the relevant income tax principles are well established, the
application of those principles to particular circumstances may be
uncertain. Considerable complexity may arise for taxpayers because
a permit can be treated differently when held by different taxpayer
types (for example, liable entities and entities that hold permits
as trading stock) or when held by the same taxpayer for different
purposes (for example, a liable entity holding permits for
surrender and other permits for sale).

Uncertainty could also arise if a liable entity purchases permits
for use, claims a deduction and then realises that too many permits
were purchased. In this case the excess permits may be banked until
required. If a permit remains banked over a number of years, there
may be a change in the purpose for holding the permit. This could
affect the tax treatment of the permit. In creating uncertainty,
the operation of the current law could lead taxpayers to use
financial intermediaries to hold permits, purchasing them only when
needed. For some taxpayers, this may not be the most efficient
method of meeting obligations under the scheme or managing risk.
The following sections illustrate how the tax treatment can change
where circumstances change.

Permits purchased to meet an obligation

Where an eligible compliance permit is purchased to meet an
obligation under the scheme, the cost of the permit may be
deductible under the general deduction provision of the income tax
law. However, it is not clear when the deduction would be
available. The cost could be deductible at the time:

. the permit is purchased

. an obligation under the scheme legally arises

. the permit is surrendered.

The tax treatment of a permit could influence the decisions of an
entity to buy or sell a permit. The existing tax law allows a
deduction at the time of purchase. This provides an incentive for
an entity to acquire permits. If the permit is sold the proceeds
would be included in assessable income. Allowing a deduction in a
different year to that in which the proceeds from sale are treated
as income could provide a disincentive for the entity to sell a
permit. That disincentive to sell could then reduce market
liquidity. This could then lead to a situation where permits are
not available to entities for which they have the most value,
reducing the cost effectiveness of the scheme.

Permits purchased and held as trading stock

The trading stock regime can be thought of as a reconciliation
process for stock on hand at the end of the income year. Where a
taxpayer purchases trading stock, the tax law allows a deduction at
the time of purchase. However, the trading stock regime also
recognises any stock held by the taxpayer at the end of the income
year in which the stock was acquired. The value of that trading
stock is included in the taxpayer's income as trading stock income.
Trading stock held at the end of an income year can be valued at
cost, market value or replacement value. Any proceeds from the sale
of trading stock are included in a taxpayer's income as trading
stock income. Taxpayers who might hold a permit as trading stock
are likely to include banks and other financial intermediaries.

Permits purchased for marketing purposes

A business entity may purchase and voluntarily surrender a permit
for promotional or marketing purposes; for example, to market
itself as 'green' or to reduce its carbon footprint when there is
no legal requirement to do so.

The cost of a permit purchased for marketing or promotional
purposes may be deductible in the same way as other marketing
costs. However, as is the case for the timing of a deduction
arising from a permit used to satisfy an obligation under the
scheme, there is uncertainty about the time at which a deduction
would be available to a business entity for a permit acquired and
surrendered for marketing purposes.

Proceeds from the sale of a permit acquired for promotional or
marketing purposes would be taken into account in determining the
seller's assessable income.

Permits purchased for investment

Where a permit is purchased for investment purposes, the cost of
the investment would be taken into account in determining any gain
or loss on the disposal of the permit.

A permit does not provide an income stream while it is being held,
with the only return being obtained by selling the permit for a
profit. If a taxpayer enters into an isolated business or
commercial transaction with the objective of acquiring an asset to
make a profit from the disposal of that asset, any profit is
assessed as ordinary income, rather than as capital gains.[85]
Consequently, it is very unlikely that a gain from a permit held
for investment purposes would be assessed under the capital gains
tax (CGT) provisions.

Interaction with the GST framework

Under normal goods and services tax (GST) rules, different types of
transactions under the emissions trading scheme will be treated
differently. For instance, payments for auctioned or purchased
permits would be subject to GST while the provision of free permits
and the surrender of permits would not be not be subject to GST.

While a separate GST framework could be established for
transactions involving permits, there is no reason to suspect that
the general provisions would result in distortions or incentives to
acquire, hold or dispose of permits in a particular manner.
Moreover, creating separate GST arrangements for the emissions
trading scheme would create anomalies in the treatment of different
transactions between emissions trading scheme transactions and
other transactions.

Options for the income tax treatment of permits

Two options that are available for the tax treatment of permits
are:

. to allow the current tax law to apply

. to amend the tax law to introduce specific provisions for
the income tax treatment of permits.

Despite the considerable complexity and uncertainty in the
application of the current tax law, it may be argued that, if
applied appropriately, the current law would generally lead to the
same outcomes regardless of why the permit is held, and so would
largely meet the objective of tax neutrality.

However, the complexity of the current tax law, with its
requirement for careful characterisation based on individual
circumstances and the resulting uncertainty that can arise for
taxpayers, could create undue compliance costs for taxpayers and
administration costs for the Government. While the uncertainty
could be managed by a combination of changes to existing law, legal
processes to test the treatments in the courts and rulings by the
Australian Taxation Office (ATO), the clarification process would
be piecemeal, slow and could still result in considerable
uncertainty.

Development of discrete legislative provisions for the tax
treatment of permits

An option for recognising eligible compliance permits which would
overcome complexity and uncertainty is to develop new provisions
within the tax law that would apply specifically to those permits.
Such provisions would provide the same general tax outcomes as
existing law, while reducing the uncertainty and complexity arising
from the application of different provisions in the current law.
New provisions would:

. allow a deduction for expenditure incurred for the
purchase of a permit

. include any proceeds from the sale of a permit in
assessable income.

An important tax consideration is the time at which the deduction
for the purchase of a permit is realised.

Allowing a deduction in the income year a permit is purchased might
not achieve the desired neutrality and could encourage entities to
hold more permits than would be optimal. The potential for a
temporal gap between the deduction for the cost of the permit and
the recognition of any income from the disposal of a permit could
result in permits being used for tax minimisation. If such a gap
existed, a tax benefit could arise because the present value of a
deduction recognised in an earlier year is greater than the present
value of the deduction in a later year.

A tax-neutral outcome is achieved by delaying the effect of the
deduction until the year the permit is surrendered or sold. This
approach would not bias an entity's decision to bank or use
permits. Similarly, it would ensure that there are no adverse tax
consequences from using or selling a permit.

Where a permit is purchased and surrendered or sold in the same
income year, a deduction would be allowed in that year. If a permit
is banked, the effect of the deduction will be deferred until the
permit is surrendered or sold. Any proceeds from the sale of a
permit would be included in assessable income in the year of sale.
To achieve this outcome, a rolling balance method will be adopted
to assess income derived from permits (see box 9.1).

|Box 9.1: The rolling balance method |
|Under the rolling balance method: |
|the cost of a permit would be deductible when the |
|permit is acquired in the same year in which the |
|permit is surrendered or sold |
|the proceeds from selling a permit would be |
|assessable in the same income year in which the |
|permit is surrendered or sold |
|any difference in the value of permits held at the |
|beginning of an income year and at the end of that |
|year would be reflected in assessable income, with |
|any increase in value included as assessable income |
|any decrease in value allowed as a deduction. |
|The rolling balance would use principles similar to |
|those used in the trading stock regime. |
|The effect of the rolling balance would be that any |
|expenditure on permits would only affect assessable |
|income in the year in which the permit is |
|surrendered or sold. Therefore, if a permit was |
|purchased and surrendered in the same income year, |
|the cost of the permit would reduce the assessable |
|income in that year. However, if a permit acquired |
|in an income year was banked, the cost of the permit|
|would not affect the assessable income in that year.|

Moreover, entities will be given the choice of adopting a market
value or historical cost approach to valuing permits within the
rolling balance method (see box 9.2).

Under the discrete legislation the capital gains tax provisions of
the tax law would not apply to transactions involving permits. In
addition, private or domestic expenditure on permits, including the
purchase of permits for the purpose of voluntary retirement, would
not be deductible (as would be the case under the current
legislation).

The benefits of this approach include:

. a simple and consistent tax treatment giving taxpayers
more certainty

. removing the need to characterise the nature of the entity
holding the permit and the reason for holding

. removal of tax minimisation opportunities arising because
there are different types of holders

. minimising administration costs for the ATO.

This approach would achieve the tax objectives outlined for the
scheme. In particular, business expenditure on permits would be
treated consistently, regardless of why the permit was held,
thereby satisfying the tax axioms of simplicity, equity and
efficiency.

|Box 9.2: Valuation method |
|An important consideration in the use of a rolling |
|balance method is the way in which permits should be|
|valued under the rolling balance. They can either be|
|valued at the original cost of acquisition or at |
|their end of year market value. |
|There is no clear policy rationale for allowing one |
|valuation method over another. |
|Valuing the permits at their historical cost will |
|require taxpayers to record the purchase price for |
|each permit until it is surrendered or sold. In some|
|cases this may be a number of years later and may |
|require keeping records for longer than the general |
|tax law requirement of five years (but maybe longer |
|in some circumstances). |
|Where permits have been banked and the value of |
|those permits has increased, the historical cost |
|approach may create an incentive to hold the permits|
|when there are other taxpayers who may value the |
|permits more highly. This is because a deduction |
|would only be available for the purchase price of |
|the permits (not the market value). There will be a |
|disincentive to sell the permits because the |
|taxpayer would have a large gain in assessable |
|income where there may be a large difference between|
|the selling and purchase price. |
|On the other hand, under the market value approach, |
|increases in the value of the permits would be |
|included in assessable income whether or not the |
|permits were sold. |
|The market value approach may lead to the taxation |
|of unrealised gains as taxpayers are assessed on any|
|change in price of permits on hand. This would only |
|be an issue if there were substantive increases in |
|the value of permits over the income year. However, |
|due to the fact that permits have no expiry date, |
|that banking and borrowing rights will exist and |
|that the end of the income year will not coincide |
|with the reconciliation of emissions and permits, it|
|is not expected that there will be significant |
|increases in permit values around the end of the |
|income year. |
|Taxpayers may prefer one valuation method over |
|another depending on their existing business |
|practices or systems. Requiring taxpayers to use the|
|market valuation method may impose additional |
|compliance costs. However, it is not expected that |
|there will be large compliance costs as market |
|values should be readily available at low cost to |
|the public as a consequence of the regular auctions |
|of permits and the expected secondary market for |
|permits. Also these costs should be relatively |
|transitionary. |
|Consultation identified that stakeholders would |
|prefer flexibility to choose a valuation |
|methodology. There are a number of advantages for |
|providing taxpayers with the capacity to elect their|
|valuation method. It would allow taxpayers to elect |
|a method which is most suited to their commercial |
|situation. It also enables taxpayers the flexibility|
|to change if circumstances change while |
|transitioning to the scheme. |
|Providing ongoing flexibility may create |
|opportunities for tax arbitrage, would introduce a |
|high compliance burden for taxpayers as well as |
|increasing administrative and compliance costs for |
|the ATO. |
|Therefore, taxpayers will be allowed to make a |
|one-off election whether to use historical cost or |
|market value to value all permits on hand. Taxpayers|
|will be able to change methods once during the first|
|five years of the scheme and not thereafter. This |
|transitional option allows taxpayers to adjust to |
|the scheme. This approach allows the taxpayer to |
|choose the method which aligns best with their |
|existing tax and accounting practices and is likely |
|to minimise compliance costs for the taxpayer. |
|Providing taxpayers a choice is at a limited cost to|
|the simplicity of the rolling balance method. It |
|will make the tax legislation more complex and |
|increases interpretative and administration |
|complexities for the ATO. |
|On balance, the preferred approach is to allow |
|taxpayers to elect the valuation option (market or |
|historic value) for a transitional period of five |
|years. While it is recognised that allowing permit |
|holders choice in methodology will involve some |
|extra complexity in the tax law, this approach is |
|preferred due to the flexibility it gives permit |
|holders. |

Consultation

The Treasury and the Department of Climate Change undertook
extensive consultation with key industry professionals on the
design of the taxation treatment of permits.

Consultation included:

. a pre-policy discussion

. information sessions in Sydney, Melbourne, Perth and
Brisbane following the release of the Green Paper

. an in-depth consultation meeting to consider any technical
and practical implementation issues.

Stakeholders were broadly comfortable with the broad policy
framework for the taxation treatment of permits outlined in the
Green Paper.

Key issues raised in consultation were around the timing of
deductions, valuation methodology, taxation of free permits, and
GST.

Stakeholder concerns around these issues and alternative solutions
were considered in the development of the taxation treatment of
permits.

Stakeholders considered that the Green Paper preferred position to
delay the deduction until when the permit is sold or surrendered
may create a timing mismatch. Stakeholders also argued that
exempting free permits from tax was necessary to prevent timing and
cash flow disadvantages.

As permits can be surrendered at any time throughout the year, for
which an upfront deduction is available, no substantial timing
disadvantage is evident as entities have the choice to match their
deductions for the cost of their permits to their actual emissions.

Cash flow issues will arise only if firms choose to bank free
permits. Further, an entity could ameliorate any cash flow issues
by selling permits on the secondary market.

Some argued that businesses could be required to pay tax on their
free allocation of permits before they had an opportunity to use
the permits.

Coal-fired electricity generators will receive free permits to
partially ameliorate the impact of the Scheme on their asset
values. Direct assistance for coal-fired electricity generators
will be provided by free permits spread equally over five years as
a form of transitional assistance. This assistance is not intended
to affect the production decisions of coal-fired electricity
generators. Rather it is provided to offset some of the losses in
their asset values. Therefore it is appropriate that assistance for
these firms be taxed in an equivalent manner to other government
assistance

However, a 'no disadvantage' rule will be included in the tax
legislation to ensure that emissions-intensive trade-exposed
entities allocated free permits will not be disadvantaged if the
surrender date following the receipt of free permits falls in the
next income year following the year in which the permits were
received. Direct assistance to emissions-intensive trade-exposed
industries will be on an annual basis and is intended to minimise
the impact of the scheme on the decision on whether to continue to
produce in Australia as emissions-intensive trade-exposed
industries are price takers in an international market.

Therefore, the Green Paper positions to defer deductions until when
the permit is sold or surrendered and to tax free permits on
receipt are recommended to be retained.

Stakeholder views were taken into account in developing a
transitional option for calculating values of permits held in the
rolling balance. Taxpayers will be able to elect a valuation
method, with taxpayers able to change valuation methods once during
the first five years of the scheme. This option was developed in
response to stakeholders seeking a flexible approach for valuing
permits at either historical cost or market value.

Some stakeholders raised concerns that the application of the
normal GST rules would lead to uncertainty about the GST treatment
of various types of Carbon Pollution Reduction Scheme transactions.
It is proposed to amend the GST law to characterise permits as
personal property (and not rights over real property) for GST
purposes to provide certainty. While establishing a discrete set of
GST rules for CPRS transactions (as proposed by stakeholders) would
also increase certainty, this would add to the complexity of the
GST law and create a precedent for developing special rules for
other classes of transactions.

Some stakeholders were also concerned that the application of the
normal GST rules would increase cash flow and compliance costs, and
result in unrecoverable GST on business inputs due to the input
taxed treatment of financial derivatives of permits. These concerns
were noted but were not considered to warrant special treatment as
cash flow and compliance costs are a normal feature of the GST
system. It was considered that introducing special rules such as
GST-free treatment (as proposed by stakeholders) to address cash
flow and compliance cost concerns would undermine the broad-based
nature of the GST system, result in different GST treatments for
like transactions in the economy, lead to calls for other
transactions to be exempt and add to the complexity of the GST.

Preferred option

Income tax

The preferred approach is to introduce discrete legislative
provisions for the income tax treatment of permits. The legislation
would make use of a rolling balance method and allow permit holders
to elect whether to use historical or market prices to value
permits in the rolling balance.

As outlined, using the generic income tax arrangements while
generally resulting in the appropriate tax treatment of permits
would be more complicated resulting in additional compliance and
administration costs for taxpayers and the ATO. The preferred
approach should result in appropriate tax outcomes while avoiding
the need to characterise the purpose for obtaining permits and
would be straightforward for taxpayers and their agents to use.

GST

The preferred approach is to make an amendment to the GST law to
characterise permits as personal property rights (and not rights
over real property).

This will promote certainty about the GST treatment of particular
type of CPRS transactions, including the GST treatment of cross-
border transactions. It will also ensure that the application of
the GST normal rules to CPRS transactions will deliver the GST
outcomes stated in the Green Paper, including generally not leading
to embedded tax for entities.

Other issues

In addition to the income tax treatment of permits, there are other
areas where the tax and accounting system will interact with the
emissions trading scheme.

The treatment of free permits

One option for the provision of assistance to affected parties is
to provide 'free' permits or cash payments. Under general taxation
principles, benefits which are directly related to the business or
income-producing activity should be included in assessable income
irrespective of whether the benefit is in the from of cash or
assets. As a result, where Government provides assistance to
industry, whether in the form of a cash payment or other grant,
such income is included in a business' assessable income and is
taxable.

An alternative approach would be to exempt the issue of permits
from the tax system which would result in no tax being paid on this
assistance. While this would increase the value of assistance being
provided to the affected parties, it would create distortions in
market for permits.

If free permits were exempt from taxation or taken to have a zero
cost an unnecessary distortion may be created. Over time, the price
of permits (both free and purchased) is expected to rise. Not
taxing the permit would create an incentive to hold the free permit
when there are other taxpayers who may value the permit more
highly. Also if a liable entity were able to choose between using a
purchased permit it had banked and a free permit it had banked, it
may choose the purchased permit because of the deduction it could
claim for that permit's use. This would mean that the tax treatment
of a permit would undermine the environmental effectiveness of the
scheme.

Moreover, exempting scheme-based assistance from the tax system
would be inconsistent with general tax principles and would place
additional strain on other tax payers and the community (who would
have to fund this tax expenditure). This option is not preferred.

The interaction with accounting rules

The accounting treatment of permits and transactions under the
emissions trading scheme will be important to the financial
accounts of many businesses. It is therefore important that
appropriate accounting standards are in place to ensure that
comparable and reliable information is provided to investors.

There is a process underway to push for the development of such
accounting standards at an international level. Australian
accounting standards are international financial reporting
standards and the preferred option is for the development of an
international standard rather than develop a specific domestic
accounting standard. This should ensure globally consistent
accounting policies in this area.

Again it is envisaged that the Australian Accounting Standards
Board (who develop Australian accounting standards) will monitor
the need an Australian standards ahead of or instead of
international standards.

10) Transitional issues

The auctioning of carbon pollution reduction permits will generate
significant revenues for the Government. The Government has already
committed to using these revenues to assist in the implementation
of the scheme and smoothing the transition for business and
households to a world with a positive carbon price. This chapter
outlines these measures. It does not consider the merits of these
programs as they are not 'regulatory' in nature.

The chapter also considers the nature of existing state based
arrangements to reduce carbon emissions and how the introduction of
an emission trading scheme will impact on those schemes.

Transitional assistance

The Government has committed to using revenue from the scheme to
assist with the introduction of the Carbon Pollution Reduction
Scheme and smooth the transition to an economy with a positive
carbon price. These assistance measures fall into four broad
groups: assistance for emissions-intensive trade-exposed (EITE)
activities, assistance to strongly affected industries, the climate
change action fund and household assistance measures. Funding for
the assistance will be sourced from both permit revenue and
budgetary appropriations. In total, it is expected if all permits
were auctioned, the value of permits would be around $11.5 billion
per year. The Government will not realise all of this revenue as
some portion of be freely allocated to emissions intensive trade
exposed firms and strongly affected industries (see below). Box
10.1 discusses the distributional impacts of this funding.

In all, the objective of the transitional assistance package is to
smooth the adverse impacts associated with the introduction of a
carbon constraint under the scheme. The impacts of the scheme will
not be felt equally across the community. Certain businesses (for
EITE businesses who are constrained in their capacity to pass on
costs) and lower income households would be likely to face more
acute impacts from the scheme in the absence of any assistance
measures.

In the case of business, the aim of the assistance is to allow them
to adjust to the introduction of the scheme in a more orderly
manner and reduce the likelihood of adverse environmental impacts
with businesses relocating offshore (to avoid the carbon price),
which is commonly referred to as carbon leakage. In the case of
households the aim is to moderate some of the higher costs
associated with the introduction of the scheme.

|Box 10.1: Distributional impacts |
|The combination of assistance packages will clearly |
|benefit some portions of the community more than |
|others. A key consideration when looking at who |
|benefits is to consider what would have happened |
|with permit revenue in the absence of the assistance|
|schemes. While the CPRS is not a tax as such, in the|
|absence of the assistance measures, revenue raised |
|from the sale of permits could be directed to other |
|Government expenditure or to offset other revenue |
|sources if there was to be no net gain to the |
|Budget. While this could conceivably benefit any |
|combination of social groups or businesses, for the |
|purposes of looking at the distributional impacts of|
|the assistance schemes it is possible that the |
|revenue would be distributed evenly throughout the |
|community. |
|If this assumption were true, the key beneficiaries |
|of the assistance packages will clearly be those |
|receiving assistance. Those who do not receive |
|assistance will be worse off relative to the world |
|in which permit revenue is shared evenly amongst the|
|community, but it is important to recognise that for|
|the most part these are households and businesses |
|who will incur fewer costs as a result of the |
|scheme. |
|The introduction of the scheme will have a |
|significant impact on the prices paid by households |
|for many goods. The most significant price rises |
|will be associated with energy prices, with retail |
|electricity prices modelled to rise by around 20 |
|percent in the five years following the scheme.[86] |
|As discussed in chapter 2, the average price |
|impacts, across all households, is estimated to be |
|1 per cent in 2010, with lower income households |
|generally incurring a slightly higher price |
|impact.[87] For instance, the price impact for |
|single pensioner households is estimated to be |
|1.3 per cent. The household and community assistance|
|packages are generally aimed at countering the |
|adverse distributional impacts of the scheme. As a |
|result the assistance package is primarily targeted |
|at pensioners and low income households. Other |
|(middle and upper income) households will receive |
|more limited assistance from the package. |
|The climate change action fund will assist |
|communities and businesses particularly affected by |
|the CPRS. While it is reasonable to assume the |
|communities with certain characteristics (those |
|heavily dependant on emissions intensive industry) |
|will benefit, until decisions are actually made |
|concerning who will receive assistance it is not |
|possible to describe the distributional outcomes of |
|this assistance. Similarly for the business |
|component of the scheme, at this stage it is not |
|possible to describe who will benefit from the |
|scheme. |
|In looking at the EITE assistance, clearly the |
|beneficiaries will be emissions intensive |
|trade-exposed industries. Again it is important to |
|recognise that these industries incur significant |
|costs as a result of the scheme, with significant |
|constraints on their ability to pass on their carbon|
|costs to the consumers of their products. So while |
|they are better off relative to a world with a CPRS |
|and no assistance, relative to a world with no CPRS,|
|they will still incur a net cost. |
|In the case of the ESAS, the beneficiaries will be |
|the most emissions intensive coal fired power |
|generators. Other less emissions-intensive power |
|generators will not receive assistance but should be|
|in a position to pass on most of the costs |
|associated with the scheme (and so will not be |
|adversely affected). |
|The impact on taxpayers will to depend to a large |
|part on the size of the assistance package. If the |
|size of the expenditure programs (the CCAF and |
|household assistance) exceeds the revenue raised as |
|part of the auction sales, the additional funding |
|will need to come from existing or new taxation |
|thereby imposing a cost on taxpayers. |

Assistance to emissions intensive trade exposed activities

The introduction of a carbon constraint under the carbon pollution
reduction scheme will place a price on greenhouse gas emissions and
will adversely affect industries which have large emissions per
unit of output (that is, emissions intensive activities), and
limited capacity to pass on their carbon costs. Although many
businesses will be able to pass on these costs to customers
(because their competitors are affected in a similar manner), some
businesses will be unable to pass on costs because they are price
takers in world markets, and compete with some producers who may
not face comparable carbon costs..

In this case, the existence of a carbon price in Australia could
result in emissions intensive trade exposed entities leaving
Australia (or choosing not to establish in Australia), so called
'carbon leakage'. If this production occurred in jurisdictions with
a similar or worse emissions intensity, Australia would be imposing
costs domestically which may not produce an environmental benefit.

To reduce the likelihood of carbon leakage, and to provide
transitional assistance to companies to adjust to the scheme, the
Government will provide assistance to EITE industries. This
assistance will be in the form of free permits and will be
revisited when there is broadly comparable carbon constraints
applying internationally. The design of the assistance scheme will
allow the provision of assistance to new industry entrants on the
same basis as for existing businesses.

Assistance to EITE companies will be provided on an activity basis
rather than an industry or company basis. Many companies undertake
a range of activities some of which will be EITE and some will not.
To ensure that assistance is most effectively targeted at the
activities that are most at risk of carbon leakage, assistance will
be provided to companies based on the particular activities they
undertake, not on industry in which they reside or some company
wide measure of emissions intensity.

To ensure that those receiving EITE assistance continue to have an
incentive to reduce emissions, it is envisaged that rates of
assistance for different activities will be set out in regulations.
Companies will receive a set number of permits per unit of
production. They will still be obliged to surrender sufficient
permits to cover their actual emissions.

The rate of assistance will depend on the emissions intensity of
the relevant activity. More emissions intensive activities will
receive greater levels of assistance although the assistance
provided will not completely shield EITE businesses from the permit
costs associated with the scheme. The level of assistance is likely
to decline over time as the number of permits (and hence level
available for EITE assistance) declines.

The EITEs assistance scheme will run until measures which impose a
carbon price broadly comparable to that under the CPRS are
introduced in competing countries.

Assistance to strongly affected industries

Assistance to strongly affected industries will be provided via the
Electricity Sector Adjustment Scheme (ESAS). The ESAS is aimed at
assisting certain electricity generators (coal-fired powered
stations) who will be adversely affected by the introduction of
carbon price. While many electricity generators will be able to
pass on the costs associated with the purchase of carbon permits
(to cover emissions), some generators who are low in the 'merit
order' will be less able to pass on costs.[88] As a result, they
are likely to incur significant costs as a result of the
introduction of the scheme including significant impacts on the
values of established assets.

The ESAS will provide assistance over the first five years of the
scheme to established coal-fired generators who are the most
emissions intensive, with the highest impacts on their asset values
over time. Assistance will be provided on an asset by asset basis -
though eligibility for assistance and the amount of assistance
provided, will be determined prior to the commencement of the
scheme, and will not be contingent on production. This decouples
assistance from ongoing production decisions and would not provide
an incentive to continue in operation when unprofitable to do so.
Assistance will be provided in the form of free permits.

The Climate Change Action Fund

The Climate Change Action Fund will be established to smooth the
transition for businesses, community sector organisations, workers,
regions and communities to an operating environment that includes a
price on carbon. The Climate Change Action Fund (CCAF) will provide
assistance by addressing the distributional impacts of the scheme
and correcting persistent market failures that impede the uptake of
lower emission technologies and processes. The CCAF will run for
five years commencing in 2008-09.

The CCAF will comprise four streams of activity:

Stream 1: Information

This stream will focus on informing small to medium sized
enterprises, non-ETIE liable entities, industrial businesses more
broadly and the community services sector about the operation of
the scheme and how they can manage the expected financial impacts.
It will also assist in addressing information failures that impede
the uptake of low emission practices and processes and energy
efficiency opportunities.

Stream 2: Capital investment in climate change.

This stream will be comprised of three measures to provide funding
for low-emission technologies and high-energy savings projects:

. Small Business Capital Allowance to assist investment in
energy efficiency equipment (eg hot water; insulation;
lighting; motor and drives; combined heat and power;
heating, ventilation and air conditioning; and
refrigeration equipment) that meets established energy
saving criteria. Priority will be given to those small
businesses that are not eligible for other forms of
assistance or receive the lowest rate of assistance under
the EITE policy.

. Community Organisation Capital Allowance to provide small
community organisations with assistance to invest in
energy efficiency equipment that meets established energy
saving criteria.

. Innovation in Climate Change to provide competitive grants
funding for low emission technologies, production methods,
supply-chain improvements or products; and high energy
savings projects with long pay back periods. Priority will
be given to those businesses that are not eligible for
other forms of assistance or are eligible for the lowest
rate of assistance under the EITE policy. Applications
would also be received from large community organisations
and local government

Stream 3: Structural adjustment provision for workers and
communities

The Green Paper indicated that while existing welfare safety net
support mechanisms and other government measures provide a means to
assist affected workers, regions and communities disproportionately
impacted by the scheme, additional support may be required in some
cases. To respond effectively to these situations this stream will
support workers, regions and communities where a clear and sizeable
burden is identified, or is likely to occur as a direct result of
the introduction of the scheme.

Stream 4: Coal Sector Adjustment

Underground coal mine operations with high fugitive emissions have
been identified as an industry sub-sector that will not be eligible
for other forms of scheme assistance, and that will be
significantly affected by the introduction of the scheme. Initially
adjustment assistance will be provided to affected coal mining
operators to promote the investigation and implementation of
emissions abatement technologies. If abatement opportunities are
not available then other structural adjustment assistance would be
provided including worker retraining and relocation expenses.

Household assistance measures

The Government has also committed to a more general household
assistance package. The package is aimed at cushioning the impact
of price increases associated with the emissions trading scheme on
households. It includes:

. Increased payments, above automatic indexation, to people
in receipt of pensioner, carer, senior and allowance
benefits and to provide other assistance to meet the
overall increase in the cost of living flowing from the
scheme.

. Increased assistance to other low-income households
through the tax and payment system to meet the overall
increase in the cost of living flowing from the scheme.

. Assistance to middle-income households to help them meet
any overall increase in the cost of living flowing from
the scheme.

. Additional support through the introduction of energy
efficiency measures and consumer information to help
households take practical action to reduce energy use and
save on energy bills so that all can make a contribution.

With the exception of the energy efficiency measures which are
likely to run for five years, the impact of the other assistance
delivered by the pension and tax and payment system will be
ongoing.

The Government has also committed to offsetting (through a cent for
cent reduction in the excise rate) the impact of the emissions
trading scheme on fuel prices. This measure will be reviewed after
three years.

Existing measures

At the State level, two major market-based emissions reductions
measures are operating in the electricity market.

The first market-based measure is the New South Wales Greenhouse
Gas Reduction Scheme (GGAS)1, which began on 1 January 2003 and was
originally scheduled to operate until 2012. In November 2005, the
New South Wales Premier confirmed his Government's commitment to
extend GGAS to 2020 and beyond. The aim of GGAS is to reduce
greenhouse gas emissions associated with the production and use of
electricity in New South Wales from 8.65 tonnes of CO2-e per capita
in 2003 to 7.27 tonnes of CO2-e per capita by 2007, and to maintain
that level until 2020.

The second market-based scheme is the Queensland Gas Scheme, which
commenced on 1 January 2005 and is scheduled to operate for 15
years. Under this scheme, Queensland electricity retailers and
other liable parties are required to source at least 13 per cent of
their electricity from gas-fired generation. The Queensland
Government subsequently revised the target to 15 per cent. Gas-
fired generators in Queensland are able to create certificates for
every megawatt hour of electricity that they produce.

The Queensland Gas Scheme aims to diversify the state's energy mix,
encouraging greater use of gas and the development of new gas
sources and infrastructure in Queensland. An associated benefit is
the reduction of greenhouse gas emissions from the Queensland
electricity sector.

With the introduction of an emissions trading scheme, the rationale
for these schemes is diminished. Both schemes have the objective of
reducing emissions from the power generation sector. The emissions
trading scheme should meet this objective in a manner that places
least overall burden on the economy.[89]

Ultimately, whether or not to cease the existing schemes is a
decision for the State governments concerned. New South Wales has
indicated that it would terminate the GGAS in the event that an
emissions trading scheme is established that would result in a
similarly stringent emissions reductions. To this end, it has
released a discussion paper considering transition options. The
Queensland Government has made no decision to halt the Queensland
Gas Scheme in the event that a national emissions trading scheme is
established. To assist with streamlining the number of schemes in
operation (and reducing the compliance costs on affected entities)
the Australian Government will discuss transitioning out of state
based schemes with the relevant jurisdictions. The form or
magnitude of any assistance provided to the states is yet to be
determined.

There is the possibility that some particular projects would be
disadvantaged by the replacement of the state based schemes with
the emissions trading scheme. This would happen where the project
is less profitable under the emissions trading scheme than the
state based scheme. For example, the Queensland Gas Scheme could
require additional investment in gas fired power generation which
would not be efficient under the emissions trading scheme. It is
expected that the cap on emissions under the emissions trading
scheme is likely to result in a scheme that is at least as
stringent as the existing schemes. In discussions surrounding the
phase out of the state scheme, the Australian Government would also
discuss arrangements for any (exceptional) projects which are
likely to be worse off under the emissions trading scheme.

11) Governance arrangements and implementation

This chapter of the RIS considers the governance arrangements for
the Carbon Pollution Reduction Scheme (the scheme) and the key
steps in the implementation of the scheme. Sound governance
arrangements are critical in delivering the scheme efficiently,
effectively and accountably.

Roles of Parliament, the Government, the Minister, the regulator and the
advisory committee

Key roles

Governance arrangements require the allocation of responsibility
for particular roles that will need to be performed in relation to
the operation of the scheme. Key roles include:

. setting the medium- and long-term national emissions
reduction targets

. setting the emissions trajectory (including the scheme
caps and gateways) to meet the national targets over time

. deciding which sectors should be covered initially by the
scheme, and on what terms

. deciding which additional sectors should be covered as the
scheme develops, and on what terms

. setting out principles and criteria for assistance to
emissions-intensive, trade-exposed industries and strongly
affected industries

. deciding whether particular entities are eligible for such
assistance

. deciding rules for the banking and borrowing of carbon
pollution permits

. applying any banking and borrowing rules to individual
cases

. allocating permits, including handling auction proceedings

. deciding which methods should be allowed for measuring and
reporting emissions

. receiving emissions data and assessing each liable
entity's obligation to surrender eligible compliance
permits

. monitoring, facilitating and enforcing compliance with the
scheme

. operating a registry to track the issuance, holding and
transfer of eligible compliance permits

. determining the nature and extent of linking between
Australia's Carbon Pollution Reduction Scheme and other
schemes operating internationally

. providing education about the scheme

. reviewing the performance of the scheme and the
effectiveness of scheme settings.

Responsibility for particular roles

Responsibility for particular roles may be allocated to:

. the Parliament, by setting out decisions, or the rules for
making decisions, in legislation

. the Government, encompassing the cabinet and the minister
with primary responsibility for the scheme

. a statutory body established to administer the scheme,
'the regulator'

. advisory or review bodies.

Submissions received in response to the Green Paper

The submissions to the Green Paper indicated overwhelming support
for an independent regulator, for integrity in decision-making,
transparency, certainty and predictability.

Some stakeholders indicated a preference for establishing a 'carbon
bank', meaning an institution modelled on the Reserve Bank of
Australia, or simply a regulator with independence for making
decisions on individual matters in accordance with the legislative
criteria and which was not subject to direction of the Minister on
individual matters. Professor McKibbin suggested that emissions
trading policy should be designed like monetary policy with a
central carbon bank managing the short-term price of carbon, given
a pre-committed Government policy on the long-term goals for the
Australian economy. Australian Climate Exchange proposed that such
a carbon bank would only perform such functions as lending of
permits, accrediting joint implementation projects and managing the
national account. It would not act as a market regulator or have a
compliance or governance role. Existing regulators would instead
fill this role.

The Green Paper proposed that scheme caps and gateways be set by
the Minister by way of delegated legislation. A number of
stakeholders raised concerns about this approach and suggested
alternatives including:

. Indicators of scheme caps and gateways should be included
in the establishing Act; actual scheme caps and gateways
should be set out in delegated legislation (BP)

. Matters the Minister would be required to consider in
making determinations should be included in the
legislation (Business Council of Australia)

. The rules for determining the scheme caps and gateways
could be set out in delegated legislation, but the scheme
caps and gateways could be administered and announced by
the scheme regulator, based upon national targets and
trajectories determined by the Government (Energy Supply
Association and others)

. The Act and ministerial powers should be favoured over
disallowable instruments, noting that the regulations
prescribing scheme caps and gateways could be disallowed
in the Parliament, creating uncertainty (CSR)

The Australian Chamber of Commerce and Industry and Origin referred
to Commonwealth-State governance arrangements, including the
National Electricity Market, an arrangement involving a rule-making
body, a separate body enforcing the regulation and the Ministerial
Council on Energy.

Origin expressed the view that it is not appropriate for the
Government to devolve such decision-making powers to a fully
independent body in the short term, but suggested as a compromise
the creation of another body without binding decision-making powers
but with a remit to provide recommendations to the Minister on
matters such as the scheme cap, gateways, coverage and annual
review. After the five year review, Origin suggested that the
Government should consider devolving decision-making to the
independent body.

Analysis of stakeholder comments

In assigning responsibility for roles to different parties, the
basic principle followed is that the Parliament and Government
should be responsible for the policy decisions with the most
significant and far reaching implications. Governance arrangements
are designed to provide as much certainty and predictability for
regulated entities and the market as is practicable, while
retaining a legitimate degree of flexibility for the Government to
adjust the scheme in response to changed circumstances. It is
appropriate that the Government, rather than regulator, is
responsible for the key decisions, as it is ultimately responsible
for the performance and implications of the scheme.

In keeping with this approach, decisions of a general nature that
are crucial to the scheme and are unlikely to change will be made
by the Parliament. These include recognition of the medium- and
long-term national targets and determining which sectors should be
covered. To create greater certainty about how these decisions will
be made, a reference to the medium- and long-term national target
ranges will be included in the objects clause of the Act
establishing the scheme and the factors that the Government may
consider when making decisions on national targets and trajectories
will be set out in the explanatory material.

The major cause of stakeholder concern is that the scheme caps
could, if set in regulations, be disallowed by the Parliament,
resulting in uncertainty around the central price determinant of
the scheme. However, setting scheme caps is akin to setting a tax
rate. While there is a risk that delegated legislation may be
disallowed, the alternative would be to remove these key decisions
from parliamentary oversight. Failure to include the scheme caps in
the legislative framework would mean there would be no legally
binding constraints on the number of permits that could be
auctioned, creating even greater uncertainty. For these reasons, it
is appropriate that decisions on scheme caps, scheme gateways and
methods for measuring emissions be made by the responsible Minister
with parliamentary oversight and be set out in delegated
legislation. To address concerns that scheme caps may be disallowed
in parliament, a default mechanism for setting scheme caps will be
included in legislation.

As identified in stakeholder submissions, the Government recognises
the need for a high level of transparency in decision-making,
public participation and the involvement of experts to ensure the
integrity of the scheme. The Government considers that these
objectives can be achieved through the establishment a scheme
regulator with a high degree of independence. The role of the
regulator will be set down in legislation and the regulator will be
given a high level of operational independence to implement the
emissions trading scheme and apply it to individual cases. The
Regulator will be accountable to the responsible minister and
subject to ministerial directions of a general nature only. Also,
an independent expert advisory committee, as proposed in the Green
Paper, will be established to assist in the realisation of these
objectives.

Table 11.1 provides further details of the functions of the
Parliament, the Minister, the Regulator and the independent expert
advisory committee.

Table 11.1: Proposed allocation of responsibility for key roles
under the scheme

The regulator

This section covers the scheme regulator's functions,
accountability, structure and relationship with the Greenhouse and
Energy Data Officer and the Renewable Energy Regulator.

The key functions of the scheme regulator will include the
following:

. Monitor, facilitate and enforce compliance with the scheme

. Determine procedures for the auction of permits, and
arrange auctions

. Determine the eligibility of individual entities to
receive free permits, and the quantity of permits to be
allocated to them

. Assess the emissions obligations of individual liable
entities, based on emissions data reported under the
National Greenhouse and Energy Reporting System

. Assess any shortfalls in eligible compliance permits
surrendered by liable entities

. Maintain a national registry of eligible compliance
permits (Kyoto units and Australian carbon pollution
permits)

. Open and close registry accounts upon request, and
transfer eligible compliance permits, as instructed by
account holders

. Conduct education, information and outreach activities
relating to the scheme

. Provide information on the national registry and other
matters, as required under Australia's Kyoto Protocol
obligations

. Publish information related to the scheme (unless
protected under the legislation)

. Exchange information with specified agencies, bodies or
statutory office holders to enable or assist them to
perform their functions.

Nature of the regulator

As foreshadowed in the Green Paper, the Government has examined the
advantages and disadvantages of amalgamating the functions of two
existing regulators, the Greenhouse and Energy Data Officer and the
Renewable Energy Regulator, with the proposed scheme regulator.
The Greenhouse and Energy Data Officer is responsible for
administering the national greenhouse and energy reporting system
and collects information on emissions levels for emissions trading
and other purposes. The Renewable Energy Regulator is responsible
for the administration of the Governments renewable energy target.
The integration of these three regulatory functions under a single
regulator would have a number of benefits:

. improved regulatory outcomes, including reduced risk of
conflicts or gaps emerging between regulators with
separate functions

. streamlining of procedures for reporting and surrender

. reduced burden for businesses that would otherwise need to
deal with two or three regulators

. economies of scale in the administration of legislation

. consistency with current Government policy on the
Governance Arrangements for Australian Government Bodies.

Stakeholders' submissions have not raised concerns about this
proposal.

To ensure a smooth transition, consolidation of the three
regulators will be implemented in a staged process with the
following steps:

. From December 2008, identification of systems and
procedures that can be consolidated from formal
amalgamation in September 2009

. Amendment of the National Greenhouse and Energy Reporting
Act 2007 and the Renewable Energy (Electricity) Act 2000
so that the one regulator performs the three functions

. From September 2009, formal establishment of the combined
regulator, with greenhouse and energy reporting, emissions
trading and renewable energy target functions co-located
and under a common internal governance framework

. Progressive integration of systems and business processes.

The regulator will continue to perform existing functions under the
National Greenhouse and Energy Reporting Act 2007 and functions
under the expanded renewable energy target. Legislation will
require this regulator to address these functions in its corporate
plan and annual report. In addition, the Government will ensure
that members of the regulator have in combination qualifications
and experience relevant to all of the regulator's functions.

The regulator will be established as an incorporated body subject
to the Financial Management and Accountability Act 1997. It will
have a commission structure with a minimum of three and a maximum
of five statutory office-holders appointed by the responsible
Minister.

The regulator will be required to report on its operations each
financial year to the responsible Minister for presentation to the
Parliament. In addition, it will be required to have a corporate
plan addressing specified matters. The regulator's decisions will
be subject to sound appeals processes, including judicial review
pursuant to the Administrative Decisions (Judicial Review) Act 1977
and merits review by the Administrative Appeals Tribunal.

Funding

The establishment and ongoing operation of the scheme regulator
will entail significant costs for Government.

These costs include employing staff to run the regulator, capital
costs related to housing the regulator and information technology
costs associated with the development and operation of an online
auction platform, the establishment of an online permit registry to
track ownership and maintenance of the online emissions reporting
platform.

In the initial years of the scheme, funding for the regulator will
be provided from the Commonwealth Budget. The desirability of cost
recovery arrangements will be considered after the implementation
of the scheme, taking into account the Government cost recovery
guidelines.

Advisory committee and review of the scheme

The Green Paper suggested that there should be periodic,
independent, public reviews of the scheme and that this would
enhance the accountability and transparency of decisions made under
the scheme. The process could also improve the environmental
integrity and economic efficiency of the scheme by fostering
consistency and predictability in decision making. It suggested
that the review advice would be made public and the Government
would take the advice into consideration when making decisions
about the scheme.

The Green Paper listed the issues that reviews might usefully
consider. It suggested that an ad hoc committee, constituted every
five years, would be appropriate for this purpose.

A number of submissions to the Green Paper referred to the review,
making varied suggestions:

. that there be more clarity about the review process

. that the five-year review be extended to include assessing
the effectiveness of household and employment assistance

. that there be fewer reviews and more depth to those
reviews that do occur

. that the first review occur after two years and then again
after another three years

. that an independent body, which would have a number of
other functions to ensure integrity of decision-making,
carry out the five-year review, and take into account the
total climate change agenda, rather than simply the
scheme.

Clearly there is a need for review to ensure that the scheme meets
its objectives, does not create any unintended consequences and is
fine tuned to optimise it performance. However, at this stage it is
difficult to determine what will prove to be the most desirable
timing - this will depend on the success of the scheme's
implementation and 'bedding down' period. That said, holding a
review too early may give undue weight to transitional issues, in
particular the operation of the scheme in the context of less
developed secondary and other financial markets than we expect to
develop over the longer term. Therefore, the preferred position is
to hold reviews every five years, or earlier if the Minister makes
a written determination specifying an earlier date.

The first review will be completed by 30 June 2014, and the
independent expert advisory committee will be constituted with
sufficient time before then for preparatory work. Adequate
secretariat support will be provided to enable the committee to
perform its functions effectively. Reviews will involve public
consultation, and the advisory committee will be required to
prepare a report of the review and give it to the minister. The
Minister will be required to table the report in Parliament within
15 sitting days of receipt. If the report includes recommendations,
the Minister will be required to prepare a statement of the
Government's response and table it within six months of receiving
the report.

The establishing Act will provide that each subsequent review will
be completed within five years after the last day on which the
Government's response to the previous review was tabled in
parliament, or earlier if the responsible Minister makes a written
determination specifying an earlier date.

The reviews will be undertaken by an independent expert advisory
committee appointed by the Minister and will consider and make
recommendations on the following:

. the effectiveness and efficiency of the scheme as a whole

. changes or extensions to the national targets

. extensions to the scheme caps and gateways

. whether additional sectors should be covered by the scheme

. assistance policies relating to households and emissions-
intensive trade-exposed industries

. the appropriateness of ongoing emissions intensive trade
exposed assistance for particular activities

. auction design

. the effect of and potential for international linking

. borrowing limits

. scheme governance arrangements, including the
responsibilities of the regulator and the responsible
minister's power of direction

. any other aspect of the scheme and its operation, which
the responsible minister may request to be reviewed.

More frequent 'care and maintenance' reviews may be necessary in
the early years of the scheme to assess the operation of
administrative arrangements. To improve market certainty, the scope
of those early reviews will be tightly defined. The conduct of such
reviews is a common administrative practice and requires no
legislative provisions.

Decisions, required either as a result of scheme reviews or for
other reasons, will be informed by appropriate regulation impact
analysis, in conformance with the Government Best Practice
Regulation requirements.

[As a regulation impact statement could not be prepared prior to
the decision to introduce an emissions trading scheme, the Prime
Minister granted exceptional circumstances relief from the best
practice regulation requirements. For this reason, a post
implementation review of this decision will be undertaken.]

Monitoring, facilitating and enforcing compliance

The Act establishing the scheme will set out a broad framework for
monitoring, facilitating and enforcing compliance. The regulator
will be given a range of compliance, investigative and enforcement
powers, with the flexibility to select from a set of graduated
options to respond proportionately to non-compliance. These powers
will include information gathering powers, auditory functions,
powers of inspection and the power to seek civil penalties or
criminal sanctions for more serious breaches. Additionally, an
administrative penalty will apply automatically in the event of a
unit shortfall (that is, where liable entities fail to surrender
enough permits to cover their emissions).

Legislation

The scheme will be implemented through unitary Commonwealth
legislation. States and Territories will be informally engaged as
part of ongoing cooperation and coordination on climate change
policy through the Council of Australian Governments.

Implementation

The intention is for the scheme to commence in the 2010 calendar
year. It is important to ensure that business is ready to implement
the scheme at this time. For this reason extensive consultation
with business and other stakeholders will continue as the
administrative systems of the scheme are developed. Using
1 July 2010 as an indicative start date for planning purposes, key
implementation steps up to 2015 are outlined in table 13.2.

Key elements of the scheme are already in place with the
commencement of the National Greenhouse and Energy Reporting Act
2007 on 1 July 2008. This Act provides key infrastructure for
reporting emissions and will assist industry to put in place
emissions reporting and build capacity prior to the commencement of
obligations under the scheme.

To ensure smooth implementation of the scheme, work has already
commenced to build additional infrastructure and capacity required
to deliver the scheme. Early implementation tasks will be
undertaken in a way that does not prejudice final decisions on
scheme design. These tasks include:

. the acquisition of a national registry (commenced in
September 2008) and other essential IT systems

. establishing the regulator

. education and outreach to enhance liable and other
entities' understanding of the scheme and its requirements
prior to the commencement of the scheme

. preparing and trialling a system for auctioning permits.

The Government will create an interim regulator in early 2009 to
ensure that key personnel are in place and administrative systems
are well advanced before the regulator is formally established
later in 2009. The interim regulator will have no statutory powers,
but will be responsible for putting in place key systems and
personnel to ensure a smooth start to the scheme.

The Government will consult on key implementation issues that
affect stakeholders, such as the development of the registry,
compliance procedures and strategy, and education and information
activities.

The Minister for Climate Change and Water will have primary
responsibility for scheme implementation.

Attachment A: Small Business Impact Statement

Small businesses are defined by the Australian Bureau of Statistics
as any business with less than 20 employees.

Direct impacts

The direct impacts on small business from the emissions trading scheme are
likely to be limited. Direct impacts refer to the obligation to acquire and
surrender permits to cover emissions. In most areas the threshold for
inclusion in the scheme is 25 kt CO2-e/year. This is a large level of
emissions and it is doubtful whether any emitter who exceeds this threshold
would be a small business (certainly they would have significant
turnover[90]).

One area where small businesses are likely to be directly covered
is in regard to transport emissions. Transport emissions are
covered by placing the liability for emissions on upstream
suppliers (that is fuel importers, producers and distributors). The
excise system is used as a mechanism to administer scheme
responsibilities - those who pay excise on fuel are also liable to
surrender carbon pollution permits for emissions associated with
the fuel sold. As there is no threshold on the excise liabilities
(small and large businesses alike are liable to pay excise), there
will be small fuel importers or producers who are required to pay
excise and who will also be required to surrender permits under the
scheme.

The impact of the scheme on small fuel importers and producers is
expected to be low. They already have to record fuel sales for the
purposes of paying excise. All that is required under the scheme is
that they multiply this volume of fuel sold by a default emissions
factor to derive an emissions liability and then surrender
sufficient permits to cover these emissions. It is expected that
entities liable for a small volume of emissions will purchase
permits from a financial intermediary (such as a bank).
Furthermore, it is expected that any costs associated with the
purchase of permits will be passed on to customers by way of
increased fuel prices (limiting the financial impact on small
business).

It is not known precisely how many small businesses will be
impacted in this way. In total there are around 250 fuel excise
remitters a portion of which are large businesses.

Another area where small businesses may incur obligations under the
scheme is in relation to the coverage of forestry. There is no
threshold limits governing the participation of forestry operators
in the scheme. However, forestry participation is on an 'opt in'
basis. As a result, small businesses would only incur costs from
the emissions trading scheme if they chose to participate in the
scheme. Moreover, forestry businesses would benefit from
participation in the scheme (they receive permits for greenhouse
gases stored in the forest) and would only opt in if the benefits
of participation outweighed any costs.

One sector that has a significant number of small businesses with
sizable greenhouse gas emissions is agriculture. At present, it is
not proposed to cover emissions from agriculture in the scheme.
This will limit the impact on small agricultural businesses (they
will still incur indirect impacts as described below). If
agriculture is subsequently included in the scheme there will be
additional impacts, but these will be considered in the context of
a decision to include agriculture.

Indirect impacts

The more important impacts on small business will be the indirect
impacts associated with increases in the price of inputs. The
emissions trading scheme will effectively put a price on greenhouse
gas emissions (referred to below as carbon emissions). Products
that 'embody' carbon emissions (that is, products where emissions
were released in their manufacture) will rise in price. The degree
of price rise will depend on the price of permits and the amount of
carbon released.

The price of permits will depend on the cap set by Government, the
design of the scheme and the cost of abatement in the economy. In
putting forward preferred positions to Government the scheme has
been designed to minimise the costs associated with meeting any
given emissions target. The coverage of the scheme is recommended
to be as broad as possible, subject to measurement and compliance
cost constraints. The broad nature of the scheme should open up
more avenues for carbon abatement, thereby ensuring that the lowest
cost opportunities are pursued first. In allowing the use of
certain international units to meet liabilities under the CPRS, the
scheme will open up international abatement opportunities which
will further reduce the costs associated with the scheme.

Nevertheless, the price of certain goods and services (those with a
significant amount of embodied carbon) will rise. Significant price
rises will be associated with electricity. Most electricity
generation in Australia is derived from the combustion of fossil
fuels which releases significant amounts of greenhouse gases. It is
estimated that the price of electricity will rise by around 20 to
22 percent over the first five years of the scheme.[91] Electricity
prices will continue to rise at a greater rate as a result of the
CPRS. By 2050 prices are expected to be between 34 and 46 percent
above the reference case (that is, the price that would have
existed in the absence of the policy action to address climate
change).

The prices of other goods are also likely to increase. In general,
produces such as metals, cement and basic chemicals which have a
high degree of embodied carbon will see the highest price rises.
Prima facie, small businesses that use these products are most
likely to be adversely affected by the scheme, although it is
expected that most will be able to pass these costs on to their
customers.[92]

The impact of the emissions trading scheme on fuel prices could
have an impact on certain small businesses (such as transport
companies and broad acre cropping enterprises). That said, fuel
prices fluctuate as a result of changes in the exchange rate and
international oil prices. The Garnaut review estimated that petrol
prices would rise by 5 cents per litre in response to a permit
price of $20. Permit prices are expected to be between $23 and $30
at the beginning of the scheme implying price increases of between
6 and 7.5 cents per litre.[93] These price rises are relatively
minor in relation to other fuel price fluctuations.

In any case, the Government has committed to offsetting the impacts
of the CPRS on fuel prices for households, on-road business users
and agricultural and fishing industries for the first three years
of the scheme. Heavy vehicle road users will have the initial
impact of the scheme offset for the first year. This will occur
through a cent for cent reduction in excise which will offset the
increase in fuel prices associated with the introduction of the
scheme. As a result, impacts on small business of petrol price
increases will be limited in the initial years of the scheme.

Overall impacts

Overall the majority of impacts on small business will result from
changes in the price of inputs. For some small businesses, which
rely on emissions intensive inputs, these may be significant.
However, it is expected that small businesses will be able pass on
the majority of these increased costs to customers.

Moreover, the impacts on small business will be in proportion to
the impacts on other businesses and households. Price rises faced
by small businesses are likely to be inline with price rises felt
by other sectors of the economy. Relative to larger businesses who
have to participate directly in the scheme, the impacts on small
businesses will be lower.

Attachment B: Compliance cost assessment

Input to Regulatory Impact Analysis
on Administrative Costs of the
Carbon Pollution Reduction Scheme

Final Report
Department of Climate Change

November 2008

Mr Russ Campbell
Assistant Secretary
Permit Allocation Branch

Department of Climate Change
GPO Box 854
Canberra ACT 2601

Private and Confidential

Dear Mr Campbell

Input to Regulatory Impact Analysis on Administrative Costs of the
Carbon Pollution Reduction Scheme

Ernst & Young has completed its procedures, as outlined in our
engagement letter dated 23 September 2008 and detailed in our Work
Plan agreed on 10 October 2008 and present this report to the
Department of Climate Change outlining our findings relating to
additional administrative compliance costs associated with the
implementation of the Carbon Pollution Reduction Scheme (CPRS).

We would like to thank you for the opportunity to work with you on
this engagement. Please do not hesitate to contact me on (07) 3011
3284 or 0417 619 388 or Mathew Nelson on (03) 9288 8121 if you have
any questions regarding this report.

Yours sincerely

Lorraine Stephenson
Partner

Contents

1. Executive Summary 199
1.1 Background 199
1.2 Findings 199
2. Scope and Limitations 200
2.1 Scope and Approach 200
2.2 Limitations 201
3. Assumptions and Criteria 202
3.1 Assumptions 202
3.2 Cost Criteria 204
3.3 Cost Categories 204
3.4 Hypothetical Companies 206
4. Analysis 207
4.1 Cost by Key Process 207
4.2 Cost by Category 211
4.3 Sector comparison 212
4.4 Uncertainty 214
5. Detailed Findings 216
Appendix A: Approach 219
5.1 Development of cost model 219
5.2 Assessment of administrative costs 222
5.3 Hypothetical Companies 228

Executive Summary

Background

The Carbon Pollution Reduction Scheme (CPRS) Green Paper was
released by the Department of Climate Change (DCC) in July 2008,
outlining the Australian Government's preferred approach to a
national emissions trading scheme. Specifically, the paper
outlines a range of design issues, for example, which industry
sectors will be covered and how emission caps will be set. It also
identifies approaches to support a robust carbon market, Emissions-
Intensive Trade-Exposed ('EITE') industries and other strongly
affected industries ('SAI'), and possible reporting and compliance
arrangements.

The Regulatory Impact Statement is developed by Government to
ensure that the costs and benefits of, and alternatives to, all new
or amending regulations that impose an appreciable burden on any
sector of the community, are examined and public comments are
sought. DCC is therefore undertaking a Regulatory Impact Statement
to analyse all the costs and benefits associated with the CPRS. As
part of developing the RIS, DCC has identified a need to assess the
specific administrative costs facing industry from the CPRS over
and above those requirements placed on them by the National
Greenhouse and Energy Reporting System (NGERS).

Findings

In order to identify and estimate the costs associated with our
analysis, eight hypothetical companies were developed to represent
a cross section of Australian industries likely to have a CPRS
liability. A summary of the findings related to these hypothetical
companies identified as a result of our analysis are presented
below:

Reporting and Compliance - For most of the hypothetical companies
the administrative costs associated with reporting and compliance
are expected to be the most significant ongoing cost. This cost
is reflective of the assurance costs required for companies
emitting greater than 125,000 tonnes CO2-e or the monitoring and
collation of data for companies without an existing NGERS liability
or an additional liability under CPRS. Our analysis also indicated
that although it is expected that most of the hypothetical
companies will require assurance, this requirement will only apply
to a minority of liable entities under the CPRS.

Significantly impacted sectors - Our analysis identified that the
company category with the highest administrative costs was the
large industrial companies followed by petroleum refiners and
electricity generators. Due to the additional administrative
processes required for waste and synthetic gas importers and an
assumption that in general these company categories include
companies with comparatively lower turnover, compliance costs on an
earning basis are expected to be higher.

Timing of costs - Start-up costs are expected to be greater than
ongoing costs for all of the company categories. Companies that
are likely to receive EITE or SAI assistance (e.g. industrial
processes and power generators) will also incur additional start-up
costs in responding to these policy measures, although applying for
this assistance will be voluntary. Our analysis indicated that the
most significant start-up costs incurred by companies are those
associated with the preparation for tax and accounting treatments
including financial systems upgrades.

Contract review - From our analysis we identified that for some of
the company categories, a key cost of implementing the CPRS is
expected to be reviewing and, where necessary, updating or
renegotiating supply side and demand side contracts. These costs
were particularly significant for the company categories expected
to have large purchase contracts (e.g. electricity contracts for
industrial use), or companies with a large customer base which are
seeking to pass on the cost of permits. However, from our
interview with a sample of actual companies, we identified that
individual companies will potentially have different exposures to
this issue and therefore the variation in potential costs are
significant with estimates ranging from $38,000 to over $1million.
It was therefore difficult to extrapolate a standard cost for each
of the hypothetical companies and as a result, these costs have not
been included in the aggregated figures for CPRS costs. Based on
our discussions it was also difficult to establish which contract
revision costs would be required to reflect compliance and which
were related to driving more advantageous business outcomes.

Scope and Limitations

Scope and Approach

Ernst & Young was engaged by the DCC to provide findings in
relation to the additional compliance costs associated with the
CPRS over and above the requirements for NGERS.

In order to determine the compliance costs, the following
procedures were undertaken:

. Established a set of criteria for determining which
additional costs related to the CPRS will be included in
the analysis.

. Determined a set of 'typical' (hypothetical) companies in
which to identify costs which would be incurred as a
result of the CPRS. The typical companies were
established to include:

- Businesses with large (>125,000 t CO2-e) and small
(<50,000 t CO2-e) greenhouse gas emission profiles

- Businesses with both mature and immature greenhouse gas
emissions reporting processes

- EITE and SAI businesses

- Businesses with upstream liability such as fuel
suppliers and synthetic gas importers

- A range of emission sources (e.g. stationary energy,
transport, industrial processes, fugitive emissions and
waste)

- Businesses with a liability under the CPRS but no
obligation under NGERS (e.g. second tier gas retailers)

- Determined what specific costs will be borne by these
hypothetical companies

- Estimated the quantum of the identified costs,
calibrated through interviews with a selection of actual
companies.

Further details of our approach and procedures undertaken can be
found in Appendix A.

Limitations

The management of the DCC shall be fully and solely responsible for
applying independent business judgement with respect to the advice
and work product provided by us, to make independent decisions, if
any, and to determine further courses of action with respect to any
matters addressed. This report should not be provided to any third
parties without our prior approval.

We disclaim all liability to any other party for all costs, loss,
damage and liability that the other party may suffer or incur
arising from or relating to or in any way connected with the
contents of our report, the provision of our report to the other
party or the reliance upon our report by the other party.

The nature and content of any advice provided necessarily reflects
the specific scope and limitations of our engagement, the amount
and accuracy of information available to us and the timescale
within which the advice is required. These services are advisory in
nature and thus do no constitute an audit or review in accordance
with Australian Auditing Standards or an engagement to perform
agreed-upon-procedures.

The following limitations and qualifications should also be noted:

The draft legislation surrounding the CPRS has not yet been
released. Whilst the Green Paper provides guidance on the
likely administrative activities, some areas of legislation
require further development such as the likely enforcement
provisions, minimum methodologies to be applied,
requirements for strongly affected industries, accounting
and taxation treatments etc. As such, the administrative
compliance cost estimates are based on a variety of
assumptions on the likely design outcomes for the scheme.

While cost estimates were validated with a small sample of
companies aligned to the associated hypothetical company, there is
limited quantitative information and evidence in key areas (e.g.
additional costs for correct taxation treatment and costs
associated with carbon markets and auctioning) and therefore
estimates for costs have a high degree of uncertainty.

Our analysis focussed on establishing the potential compliance
costs of an assumed base case approach to ensuring compliance with
the CPRS.

Assumptions and Criteria

Assumptions

As set out in our scope above, the first step in developing the
model to assess the administrative costs associated with the
compliance requirements for the CPRS is to establish a set of
criteria and assumptions to guide the model. In undertaking our
analysis, the following key assumptions were made:

Substantive compliance costs, including the direct costs of
purchasing carbon permits, pass through costs from suppliers, costs
associated with raising funds for the purchase of permits and costs
associated with implementing internal abatement projects are
excluded (we understand that these costs will be identified and
assessed as part of the general equilibrium modelling undertaken by
the Treasury).

Compliance costs are assessed as either:

. 'start-up' costs: costs associated with activities
undertaken prior or immediately subsequent to CPRS
commencement

. 'ongoing' costs: costs associated with activities required
to be undertaken on an annual basis in the early years of
preparation and scheme commencement

In lieu of draft CPRS legislation, compliance requirements are
determined based on the preferred positions documented in the
Government's Green Paper, July 2008.

Where the Green Paper preferred positions are not definitive, the
following assumptions have been made:

. liability is determined on an operational control as
defined in NGERS

. there will be compliance activities associated with
obtaining assistance in the form of cash payments and free
permits; however the assistance once provided is not tied
to additional reporting or performance requirements
(except for annual production reporting for free permits).

Companies will be assessed from a base-case scenario consisting of
a minimum level of scheme participation and full compliance (i.e.
no international trading, no brokering, limited management of
increased debt, limited periodic permit purchase and acquittal, no
enforcement of compliance required)5[94].

Contract revision costs have been excluded from the base case
compliance assessment due to the large variability in these costs
to an individual company (e.g. dependant on the nature of the
business and the completeness of existing contracts) and the
potential contribution of the contract revision to drive better
business outcomes rather than just to achieve minimum compliance
(e.g. where supply contracts are revised and negotiated to reduce
the impacts of cost pass through).6[95]

As agreed with DCC, the cost model and cost criteria are based on
the Victorian Competition and Efficiency Commission's (VCEC)
Victorian Guide to Regulation.

Cost Criteria

For the purposes of our analysis, the cost model and cost criteria
used are based on the VCEC's Victorian Guide to Regulation. Under
the VCEC Guide, compliance costs can be defined as:

Substantive compliance costs - those costs that directly lead to
the regulated outcomes being sought such as capital outlays and
production costs. These costs are often associated with content-
specific regulation and include, for example, the cost of
purchasing carbon pollution permits.

Administrative costs - administrative costs are those costs
incurred by business to demonstrate compliance with the regulation
or to allow government to administer the regulation. Administrative
costs can include those costs associated with familiarisation with
administrative requirements, record keeping and reporting,
inspection and enforcement of regulation.

As agreed with DCC, our analysis is focused on the administrative
costs of compliance with the CPRS rather than substantive costs
which we understand are examined in other ways including through
general equilibrium modelling undertaken by the Treasury.

Cost Categories

For the purposes of our analysis, the administrative costs have
been broken down into five cost categories as outlined below.
These categories have been amended from those provided by the
Office of Best Practice Regulation (OBPR) guidelines which are
recommended for use by government entities who propose to introduce
various regulatory instruments and are required to indentify and
quantify the associated business compliance costs.

As noted in the assumptions, compliance costs are assessed as
either 'start-up' costs for once off activities undertaken prior to
CPRS commencement or 'ongoing' costs for activities required to be
undertaken in the early years of preparation and scheme
commencement. The ongoing cost time frame defined in the early
years of preparation and scheme commencement reflects that these
costs are likely to be more significant in the initial period the
scheme and have the potential to fall over the longer term as they
are incorporated into standard business practices.

In addition to analysing costs by the cost category as outlined
above, the administrative cost assessment was undertaken of key
processes required to be undertaken to achieve legislative
compliance. The Government's preferred positions as outlined in
the Green Paper were used to categorise the following five key
processes:

Hypothetical Companies

In order to identify and estimate the costs associated with the
analysis, eight hypothetical companies were developed to represent
a cross section of Australian industries likely to have a CPRS
liability. The companies were selected to ensure coverage of key
emission sources including stationary energy, fugitive, industrial
processes, waste and transport and an attempt to cover other key
differentiators including the quantity of emissions, maturity of
reporting and additional CPRS requirements for companies classed as
EITE, SAI or companies with upstream liability under the CPRS (Note
that applying for assistance under EITE or SAI or responding to
Government requests for related information is voluntary).

Refer to section 5.3 in Appendix A for further details on the
selection and description of hypothetical companies.

Analysis

From our discussions with a sample of impacted companies and our
own analysis, the start-up and ongoing costs required to comply
with the CPRS are expected to be relatively small in comparison
with:

. complying with the requirements of NGERS7[96]

. the substantive costs associated with the purchase of
credits or

. the commercial costs associated with seeking to optimise
the business outcomes of trading.

Although the administrative costs are not expected to be
comparatively significant, our analysis identified that the ongoing
and start-up administrative costs of compliance in some cost
categories were identified as material.

Outlined below are details of our specific findings and outcomes of
our analysis related to these identified costs.

Cost by Key Process

Carbon Markets and Permits

The introduction of the CPRS will require companies to consider a
range of commercial arrangements in order to ensure they are
compliant with the CPRS and other legislative frameworks. Start-
up and ongoing costs associated with Carbon Markets and Auctioning
Permits are both expected to be significant. The most significant
contributor to this start-up cost identified across all companies
was the cost associated with management's review of organisational
strategy and assessment of the business implications of the CPRS as
well financial modelling of potential cost pass through.

Our analysis also identified that costs associated with the
modelling of cash flows for the purchase of permits is likely to be
a material ongoing cost for most of the company categories and in
particular for large emitters or companies with complicated supply
chains. Another potentially significant cost to companies is the
cost associated with raising funds for the purchase of permits.
This cost is highly dependent on the number permits to be purchased
and thus the quantity of liable emissions and also on the financial
structure of the organisation. As such the administrative costs of
planning and modelling various funding options have been included
in this assessment, but the actual financial costs of raising
capital have be excluded.

It is also worth noting that in some circumstances, companies will
be seeking to pass on the substantive costs of the CPRS and may be
collecting revenues in advance of the need to purchase permits.

Another additional and potentially significant cost identified
beyond the base case assessment, was associated with the process of
revising and negotiating both purchase and sale contracts
throughout the supply chain and notifying customers of contractual
changes. For example, contract revisions likely to incur costs
include:

. Purchase contracts - costs associated with the revision of
purchase contracts for items such as gas, electricity and
steam.

. Sale contracts - costs associated with redrafting sales
contracts for companies with a large customer base.

Whilst contract revision costs are likely to impact all
hypothetical companies, some sectors and companies are likely to be
impacted more considerably than other. Companies in the gas retail
sector may be more significantly impacted due the large customer
numbers for review and notification and potential contract
variability between sets of customers, with costs of over $1
million expected for some companies. Some large industrial
processors are also likely to be more significantly impacted from
the revision of large long term supply contracts.

As noted in the assumptions, contract revision costs, whilst
significant, have been excluded from the base case compliance
assessment due to the large variability in these cost to an
individual company and the difficulty in establishing which
contract revision costs would be required to reflect compliance and
which were related to driving more advantageous business outcomes.

Figure 1: Cost by Key Process (average cost across relevant
hypothetical companies)

[pic]

Reporting and compliance

Our analysis indicated that on average the cost category related to
Reporting and Compliance had the most significant ongoing costs for
all hypothetical companies (see Figure 1). Whilst many of the CPRS
greenhouse gas emissions reporting requirements are underpinned by
NGERS and have previously been considered as part of the analysis
of the NGERS RIS, we have identified additional reporting and
compliance requirements under the proposed CPRS design.
Specifically, additional reporting and compliance costs for the
CPRS identified from our analysis across company categories
include:

. Assurance - for entities emitting over 125,000 tonnes CO2-
e, assurance will be required which will incur both
external and internal costs. Additional assurance
requirements for entities emitting less than 125,000
tonnes CO2-e may also be required where emissions or
permits are material for financial statements. Note, some
large companies may already be obtaining assurance over
greenhouse gas emissions (voluntarily or through programs
such as Greenhouse Challenge Plus), so for these companies
the additional assurance compliance cost are substantially
reduced.

. Frequency of greenhouse gas emissions data capture - it is
expected that companies will need to capture emissions
data more frequently than is required under NGERS, as data
will be required for management accounting purposes (e.g.
forecasting of financial costs) and preparing for permit
auctions.

Companies with additional or new reporting liability under CPRS
(compared with NGERS reporting obligations) may also face
additional costs related to education of personnel, monitoring and
reviewing of reporting legislation and development of data capture
processes, including transfer of sales related data and netting out
and measuring and collating additional liable emissions data (e.g.
customer gas use, imports of synthetic gas).

Tax and Accounting

Our analysis indicated that on average the cost category related to
Tax and Accounting issues had the most significant start-up costs
for all hypothetical companies (see Figure 1 above), with the
largest contributor from the systems capacity upgrade to link
operational and financial data. Tax and accounting compliance is
also expected to result in some ongoing costs for company
categories including activities associated with accounting for the
liability and the permits in annual reporting and business activity
statements. From our discussion with companies, we note that the
general understanding of tax and accounting issues related to the
CPRS is limited with details of the requirements under the CPRS
design still to be established. It is important to note that cost
estimates under this category are difficult to estimate due to the
uncertainty in the legislation and the companies' progress in
dealing with tax and accounting elements. The selection of either
of the two valuation methods presented in the Green Paper:
historical and market value, is also likely to have an impact on
the costs incurred related to tax compliance. Our estimates have
assumed that the CPRS will be implemented using the simpler of the
two valuation methods for tax treatment.

Emissions Intensive Trade Exposed/ Strongly Affected Industries

Companies with the potential to be classified as EITE or SAI may be
required to execute on a number of specific additional activities
and therefore face increased compliance costs in order to gain
assistance in the form of upfront cash grants or annually allocated
free permits. These costs result mainly from the anticipated
development of an application for assistance and the application of
correct tax and accounting treatments for the assistance provided.
In addition, assurance of historical data is a significant once off
cost that may be required for the EITE process along with
additional compliance costs associated with companies potentially
being required to provide information related to a 'Gross Value
Add' metric. As noted in the section 3.1, we have assumed that once
the assistance is provide there are no additional ongoing costs
associated additional reporting or performance requirements tied to
the free permit or cash grant.

Cost by Category

The greatest compliance costs faced by companies are start-up costs
in the other cost category including legal, tax and accounting
costs and transaction costs associated with purchase and acquittal
of permits. Other costs also include costs associated with
applying for assistance under EITE or SAI. Most materially and
consistently across companies within this cost category is the
requirement to upgrade internal systems for reporting and
monitoring purposes.

Figure 2: Cost by Category (average cost across all companies)

[pic]

Reporting costs are low across most companies due to the alignment
with NGERS reporting requirements. Of note, reporting costs are
higher for companies without NGERS or with additional liability
above NGERS. Assurance costs as a subset of reporting are a more
significant and ongoing cost especially for companies with
emissions great than 125,000 tonnes CO2-e.

As noted in the description of cost categories (Section 3.3), many
ongoing costs are likely to be more significant in the initial
period of the scheme and have the potential to fall over the longer
term as they are incorporated into standard business practices.
For example, in the longer term costs associated with standard
business activities such as monitoring and reviewing legislation
and pronouncements from tax and accounting bodies would be expected
to fall. Ongoing costs that are not likely to reduce in the longer
term as those associated with new business requirements such as
assurance of annual emissions.

Sector comparison

Our analysis identified that the greatest start-up compliance costs
will be faced by industrial processors, followed by petroleum
refiners and electricity generators. Ongoing costs are likely to
be consistently more significant across upstream oil and gas,
electricity generators, industrial processors, petroleum refiners
and gas retailers.

Figure 3: Cost by Hypothetical Company (total cost)

[pic]

It is important to note in the context of the company categories
that our analysis does not provide consideration of compliance
costs on an earnings basis, potentially impacting the perceived
burden of companies in the waste and synthetic gas (without pre-
existing liability) sectors.

Outlined below are details of our specific findings related to each
hypothetical company:

. Upstream Oil and Gas - Start-up costs are largely a result
of the required systems capacity upgrade to link
operational and financial data, as well as management
review around the business implications of the CPRS. Oil
and Gas companies also face costs associated with the
additional requirement to collect and report data
associated with its LPG/LNG liability. Ongoing costs are
increased by the requirement to annually gain assurance
over emissions. It has been assumed that this
hypothetical company is not eligible for EITE assistance.

. Electricity generator - Electricity generators are also
likely to face increased start-up costs as a result of
activities surrounding systems capacity upgrade,
management review around the business implications of the
CPRS as well as the additional costs associated with
obtaining SAI assistance. Ongoing costs are increased by
the requirement to annually gain assurance over emissions.

. Synthetic gas importer - Significant start-up costs are
likely to be associated with the systems capacity upgrade
and enhancing data collection and reporting systems due to
absence of a pre existing NGERS requirements. There is a
potential cost overlap with the reporting requirements of
the Ozone Protection and Synthetic Greenhouse Gas
management Act 1989.

. Industrial processor - Industrial processor start-up
compliance costs are likely to be larger across the board
due to the size and complexity of the businesses in this
sector. Although not included in the base case, some of
these companies are likely to face significant contract
revision costs for large supply contracts such as
electricity. Additional start-up costs are required to
gain and manage EITE permits and upgrade systems capacity.
Ongoing costs are increased by the requirement to annually
gain assurance over emissions.

. Petroleum refiner - Petroleum refiners' start-up costs are
increased by the activities associated with gaining,
managing and accounting for EITE permits, including
assurance over historical emissions and application
development. Other significant start-up costs for this
sector include systems upgrade to capture the additional
downstream liability and education and management review
around the business implications of the CPRS. Ongoing
costs are increased by the requirement to annually gain
assurance over emissions. Although not included in the
base case assessment, petroleum refiners will also need to
consider the costs associated with the revision of
contracts.

. Manufacturer - The smaller manufacturing company is likely
to face the smallest ongoing compliance costs largely due
to the absence of a requirement to obtain assurance over
emissions data. Significant start-up costs for the
smaller manufacturer are likely to be associated with
systems capacity upgrade to link operational and financial
data and the additional costs associated with reviewing
contracts both for customers and suppliers.

. Gas retailer - Non-integrated or second tier retailers
face start-up costs associated with enhancing data
collection and reporting systems due to absence of a pre
existing NGERS liability. Ongoing costs are increased by
the requirement to annually gain assurance over emissions.
Although not considered in the data presented in this
report, it is important to note that in some cases gas
retailers potentially face large contract review and
notification costs based on large customer numbers.
Companies with customers in the order of 300,000 to
500,000 may face associated costs in the range of $1-2
million. Given that this cost is based largely on
customer numbers and the ability of existing contracts to
pass through the liability, some gas retailers may have
substantially reduced compliance costs.

- Gas retailers or other companies with a high volume of
customers also potentially face additional costs from
the education and management of customers as well as the
increased debt portfolio they will carry as a result of
the pass through of the costs of the CPRS onto customer
invoices. The costs associated with managing an
increased debt portfolio are difficult to estimate due
to differences in a company's financial structure.
Whilst these costs have the potential to be significant
for some sectors, they have not been estimated in this
assessment of compliance costs.

. Waste treatment - Significant start-up costs for the waste
sector are likely to be as a result of activities
associated with contract revisions, management review of
the business implications and modelling the potential cost
pass through to customers.

Uncertainty

It is important to consider the uncertainty surrounding the
estimate of start-up and ongoing compliance costs in order to place
the estimates in context and understand in more detail which
estimates are more likely to change. An overall uncertainty has
arisen from the limited knowledge of future regulatory requirements
due to timing of this assessment being undertaken prior to the
release of draft CPRS legislation. To manage this and other
uncertainties the cost assessment was undertaken within a range of
assumptions to simplify and clarify boundaries and likely
regulatory requirements. (See Section 3.1 for details of the
assumptions). If assumptions were to change, there is the potential
for significant changes to cost estimates. In this respect, key
assumptions include base-case scenario consisting of a minimum
level of scheme participation and full compliance and the exclusion
of substantive costs. Many companies indicated significantly
greater costs to the organisation from the CPRS (e.g. setting up a
trading desk, assessing and implementing abatement opportunities,
systems and data collation to meet high calculation levels etc.)
but the costs associated with these activities were determined to
be either substantive costs or cost incurred by activities assumed
to be over and above the base case assessment.

By Sector

In discussions with companies the uncertainty around compliance
cost estimates was found to be the greatest in the sector with
responsibility for synthetic gas liabilities. This is potentially
due to this sector not having a reporting obligation under NGERS as
well as the uncertainty surrounding the relevant preferred
positions in the Green Paper such as the threshold and the state of
preparedness of companies in this sector. Some companies in this
sector with a likely liability had not begun to consider the
required compliance activities for the CPRS.

Discussions in the waste to landfill sector identified
inconsistencies within the sector as to the most appropriate
measurement techniques for greenhouse gas emissions and the costs
associated with implementing higher order methods. This divergent
view should be considered when determining if additional method
requirements will be placed on the waste sector as identified in
the Green Paper. There was a level of inconsistency between
companies in all sectors due predominantly to variances in the size
and nature of the organisation being interviewed.

By Key Process and Cost Category

Based on the conversations with companies we noted a greater level
of uncertainty associated when estimating the cost of compliance
activities such as the purchase of and surrender of permits as well
as activities surrounding tax and accounting issues. The
uncertainty around tax and accounting activities could potentially
be related both to the lack of certainty provided by the Green
Paper and the stage at which most companies are at in preparing for
the CPRS. To improve the certainty around the tax and accounting
cost estimates, internal consultations were undertaken with Ernst &
Young's tax and accounting specialists.

Due to a more mature market and previous experiences, estimates for
monitoring, record keeping, reporting and assurance cost categories
were more certain than those in the other categories.

Detailed Findings

The following tables display the detailed findings of stat-up and ongoing
costs for each cost category across all hypothetical companies.

Table 1 and 2: Start-up and Ongoing costs by cost category

Provided below are further details in relation to each of the above
parameters for calculating the hypothetical company daily labour
rate

The costs of purchases are then added to the labour cost rate and
labour hours requirement multiple for all processes and activities
to arrive at a total cost for each activity (both start-up and
ongoing). Further, effective annual costs are able to be
calculated by spreading the start-up cost by the user-defined
regulation horizon.

For each hypothetical firm, the costs are reported as:

. Total cost for the firm

. Cost by key process

. Cost by cost category

. Start-up versus ongoing cost.

Industry specific ABS Daily Rate

In determining industry specific ABS rates we have used
"6348.0.55.001 - Labour Costs, Australia, 2002-03 " ABS product
which lists per employee costs for various industries. Where
possible relevant industry data was used and where the industry was
not on the list, the average 'All Industries' figure was applied.

Costs included in the ABS data are:

. Employee Earnings

. Superannuation

. Payroll Tax

. Workers Compensation

. Fringe Benefits Tax

The total annual labour costs are converted into daily rates by
first dividing the cost by a number of weeks, and then a number of
working days per week. Currently we have assumed a 5-day working
week, and 44 working weeks a year. 44 weeks per year are set using
the VCEC guidance where 4 weeks are due to statutory requirements
for annual leave, 2 weeks are due to public holidays and further 2
weeks due to unscheduled absence (e.g. long service or maternity
leave).

The ABS data used was the most recent available which was for the
financial year 2002-03. Therefore, in calculating costs we have
uplifted to 2008-09 costs by incorporating six years of inflation
assumed to be an average of 2.5%.

Professional Staff Wage Mark-up

In calculating a relevant daily labour rate, we have added a mark-
up to the ABS data to account for the fact that the employees
required to undertake the administrative tasks will be
significantly higher earners than the average for the particular
industry. Our analysis indicated a 100% mark-up was required
considering the qualifications and experience of personnel likely
to be undertaking CPRS compliance related activities and the
average increased salaries expected for these professionals.

Specifically, the proportion of activities undertaken by each
employee type was estimated for each line-item activity in the
model and then multiplied by a labour cost mark-up - reflective of
the difference between average 'All industries' earnings in the ABS
data and the average wage for each employee type9[98]. The
following table details the estimated proportion and cost mark-ups.

|Employee Type|Proportion of |Additional|Cost of |
| |activities |labour |labour |
| |undertaken by |cost |factor |
| |employee type |mark-up | |
|Engineering |15% |3.1 |0.47 |
|Legal |25% |2.4 |0.6 |
|Admin |10% |1 |0.1 |
|Finance |50% |1.7 |0.85 |
|TOTAL | | |2.02 |
|Cost of labor| | | |
|factor | | | |

Overhead costs

Following VCEC guidelines, a 50% mark-up was applied to the ABS
labour cost data to account for a company's overheads in employing
professional personnel such as providing computers, office space
etc.

Key departure from the VCEC model

While the model developed for DCC is in many ways an upgrade of the
VCEC SCM, there are two key areas of departure from that model.
These are due to DCC's stated requirements and are identified here
for reference.

First, the VCEC model calculates the economy-wide administrative
burden so that the total cost per business is multiplied by the
expected number of businesses affected.

Second, under the VCEC model five businesses are interviewed to
determine average administrative costs across the entire economy.
As we have considered a number of hypothetical firms within the
economy, we have conducted one to three interviews per hypothetical
firm type to supplement Ernst & Young's own estimates. The
interviews were not conducted primarily to determine costs, but to
either support Ernst & Young estimate or to provide an alternative.

Assessment of administrative costs

As noted in the body of the report administrative costs were
analysed both on a cost category and key process basis.

Cost categories included:

. Education/Capacity Building

. Enforcement:

. Monitoring/ Record Keeping:

. Reporting/Notification:

. Assurance (sub-set of Reporting/Notification):

In order to focus on the additional administrative costs associated
with the CPRS, the Government's preferred positions as outlined in
the Green Paper were used to categorise the actions required by
industry to prepare for its introduction in 2010.

Specifically, each of the Green Paper's preferred positions was
assessed for its compliance requirements and additionality to NGERS
requirements. Those chapters with positions assessed as requiring
additional administration were then grouped into five specific
Processes, each with its own set of Activities which companies
would likely undertake to support its compliance with each
requirement.

The Processes used to group activities with administrative
requirements are defined as follows:

The activities identified as contributing to achieving
administrative compliance within each of the above processes are
defined as follows:

The activities outlined in the above table were not undertaken by
all hypothetical companies. For example, activities associated
with the Strongly Affected and Emission Intensive Trade Exposed
processes are relevant only for companies likely to fall into this
category. Some of the other key exceptions/alignments include:

. Sale of permits: most relevant of companies receiving EITE
free permits

. Assurance over emissions: full external assurance is
relevant for companies with emissions greater than 125,000
tonnes CO2e, however additional financial assurance
requirements are also likely when emissions are less than
125,000 tonnes CO2-e but are material to financial
statements

. Monitoring, collection and collation of emissions data:
whilst these processes are assumed to have been undertaken
for NGERS, there are likely to be additional data
collection and collation requirements for companies with
additional or new liability under the CPRS, such as
companies with upstream fuel liability and companies
without existing NGERS liability.

An initial assessment of likely compliance costs for each of the
above activities was undertaken by Ernst & Young. This cost data
was then validated through interviews with companies fitting the
hypothetical company description. The interviews were a key step
in calibrating the reasonableness and completeness of cost
estimations and also provided qualitative insights into various
industries preparedness for the CPRS.

Note: The details of these interviews remain confidential and have
not been disclosed to any party.

Hypothetical Companies

Eight hypothetical companies were developed to represent a cross
section of Australian industries likely to have a CPRS liability.
The following definitions were used in characterising the above
hypothetical companies.

Companies with emissions output from the stationary energy sector,
industrial processes, waste treatment, transport use or fugitive
emissions were covered. These eight companies are described as
Company A to H below:

. Company A - Large upstream oil and gas company

Large upstream oil and gas company with emissions greater
than 125,000 tonnes CO2-e and mature reporting processes.
Emissions originate from stationary energy, fugitive
(transmission and flaring) and transport (LPG/LNG). Note:
Additional upstream liability for transport emissions
(LPG/LNG). Assumed not to be eligible for EITE
assistance.

. Company B - Large electricity generator

Large electricity generator with emissions over 125,000
tonnes CO2-e and mature reporting processes. Assumed to
be characterised as a SAI and receive government
assistance.

. Company C - Importer of synthetic gas

Importer of synthetic gas, in bulk or within commercial or
household equipment, liable under CPRS but not NGERS for
emissions output from its downstream customers, generally
emissions below 50,000 tonnes CO2-e with immature emission
reporting systems.

. Company D - Large, international industrial processor

Large, international industrial processor from the steel,
pulp & paper, aluminum, cement or glass sectors. Many
companies have immature reporting systems but have large
emissions output from stationary energy use, industrial
processes and some fugitive emissions. Assumed to be
characterised as EITE and eligible for assistance.

. Company E - Petroleum refinery

A petroleum refinery with emissions greater than 125,000
tonnes CO2-e from stationary energy, industrial processes,
transport (LPG and petroleum products) and fugitive
sources. High emissions output and mature reporting
systems. Liable for upstream emissions and characterised
as EITE.

. Company F - Small - medium size manufacturer

Small to medium size manufacturer with emissions from
energy use and industrial processes from each site.
Companies have emissions less than 50,000 tonnes CO2-e per
year and immature greenhouse gas reporting systems.

. Company G - Gas retailer

A non integrated gas retailer with emissions generated by
the downstream household and small commercial use of gas.
Gas customer numbers are assumed to be in the order of
300,000 to 500,000. Emissions are above 125,000 tonnes
CO2-eand companies generally have immature greenhouse gas
reporting processes. This company does not have a
liability under NGERS.

. Company H - Waste treatment company

Landfill operator with emissions less than 50,000 tonnes
CO2-e and immature greenhouse gas reporting processes.
This company does not have a liability under NGERS.

Attachment C: Existing measures

Cross sectoral action to reduce emissions

The Greenhouse Gas Abatement Programme - aims to reduce Australia's
net greenhouse gas emissions by supporting activities that are
likely to result in substantial emission reductions or substantial
sink enhancement, particularly in the Kyoto target period (2008-
2012). Challenge Plus - Industry Partnerships, which includes the
Generator Efficiency Standards and Greenhouse Friendly programmes,
reduces greenhouse gas emissions, drives continuous improvement and
enhances knowledge and understanding of cost-effective ways of
managing greenhouse gas emissions. The Greenhouse Friendly
certification program provides Australian businesses with the
opportunity to market greenhouse neutral products or services,
deliver greenhouse gas abatement and give Australian consumers
greater purchasing choice.

Action to reduce emissions from the Stationary Energy sector

Renewable Energy Measures - 20% Renewable Energy Target will ensure
an additional 45,000 GWh of renewable energy per year by 2020. This
policy intends to build on the Mandatory Renewable Energy Target
which has been in place since 2001. In addition, the Australian
Government supports commercialisation and use of renewable energy
technologies and related industry development initiatives through a
range of programmes such as the Renewable Energy Fund and the
Energy Innovation Fund.

Action on Energy Efficiency - Through this measure, the Australian
Government is working with industry, business, the community and
all levels of government to increase the uptake of cost-effective
energy efficiency opportunities that will reduce greenhouse
emissions, reduce energy demand, and improve Australia's
competitiveness. This includes the continuation and enhancement of
energy efficiency labelling, Minimum Energy Performance Standards,
for appliances, equipment and buildings, improvements to the energy
efficiency of government operations and by requiring businesses to
identify, evaluate and report publicly on cost effective energy
saving opportunities (Energy Efficiency Opportunities Programme).

The updated projections also include a number of new energy
efficiency measures announced by the Australian Government,
including the Phase-out of Electric Hot Water Heaters, the
Insulation Rebate for Renters, Green Loans for Households and the
enhancement of Government Energy Efficiency requirements.

Action to reduce emissions from the Transport sector

The Environmental Strategy for the Motor Vehicle Industry - is a
nationally coordinated measure to enhance the environmental
performance of the automotive industry through measures including
consumer information programs and fuel consumption targets.

Governments Biofuels Measures aim to increase the availability of
biofuels for the domestic transport market. These initiatives aim
to support the commercial development of the Australian biofuels
industry, through the 350 ML target and specific biofuels
development projects. Other transport initiatives include the
Alternative Fuels Conversion Programme and Travel Demand Management
programmes, which promote the use of alternative fuels and improve
public transport and town planning.

Action to reduce emissions from the Fugitive sector

Reductions of Fugitive sector emissions reflect the increased
tendency to capture methane from coal or gas mining operations,
either for power generation or flaring.

Action to reduce emissions from the Industrial Processes sector

Through the implementation of the Ozone Protection and Synthetic
Greenhouse Gas Legislation Amendment Act the Australian Government
is working with industry to control the import and the end use of
synthetic greenhouse gases and ozone depleting substances.

Action to reduce emissions from the Waste sector

The Australian, State and Territory Governments have introduced
waste management strategies and targets that aim to reduce the
amount of waste sent to landfill, and to increase the methane
capture from landfills and from wastewater treatment facilities.
Abatement is realised through a range of measures, including the
Mandatory Renewable Energy Target, Greenhouse Friendly, the New
South Wales Greenhouse Gas Abatement Scheme.

Action to reduce emissions from Agriculture and Land Use Change and
Forestry

The Queensland and New South Wales Governments have adopted reforms
to their respective vegetation management legislation that are
expected to significantly reduce land clearing rates in the two
States. These two States contribute the bulk of national land use
change emissions. The Australian and State and Territory
governments are also working together to implement the Greenhouse
in Agriculture and Regional Australia Program including a targeted
agricultural emissions programme, incentives for greenhouse sinks,
and strategies to integrate greenhouse gas abatement intoother
regional priorities such as natural resource management planning.

Do not remove section break.

Review of

Input to Regulatory Impact Analysis
on Administrative Costs of the
Carbon Pollution Reduction Scheme

by Ernst & Young

Prepared for the Department of Climate Change
by
George Wilkenfeld and Associates Pty Ltd

April 2009

Review of Input to Regulatory Impact Analysis on Administrative costs of
the Carbon Pollution Reduction Scheme by Ernst & Young

Background

This review, commissioned by the Department of Climate Change
(DCC), analyses the report Input to Regulatory Impact Analysis on
Administrative for the Carbon Pollution Reduction Scheme, prepared
for DCC by Ernst & Young (EY 2008). The EY report forms the basis
of the compliance cost estimates carried forward into the main RIS
(RIS 2008, Box 3.2).

DCC requested George Wilkenfeld and Associates (GWA) for:

. 'An analysis of the document and the extent to which
activities identified as compulsory are in fact necessary
in order to comply with the CPRS.

. Identification of costs which you believe to be
significantly different from your perspective,
incorporating your knowledge of NGERS requirements and
costs.'

It is noted that EY (2008) was prepared after the publication of
the Green Paper in July 2008 but before the publication of the
White Paper in December 2008 and the release of the draft CPRS
legislation in March 2009. Quite reasonably, EY made assumptions
about matters relevant to administrative costs which were left open
in the Green Paper. While the White Paper and the draft legislation
have in most cases confirmed the 'Green Paper Position' as a
'Policy Position', there are some areas where the added detail
would be relevant to the assessment of administrative costs.

One example is the Obligation Transfer Number (OTN) system by which
both upstream and downstream entities with liabilities for
emissions from fuel combustion could manage their obligations more
efficiently. This and other refinements could well impact on EY's
assessment of costs.

The present review is based on both the text and the numerical data
tabulated in EY (2008) and in Box 3.2 of the RIS. A spreadsheet was
prepared to assist with this numerical analysis, and to help in
assessing the impact of varying EY's cost estimates.

However, given the brevity of the scope and period for review, the
author was not in a position to refer issues to EY or to conduct
parallel investigations.

Review Of Costs Elements

EY (2008) analyses administrative costs to CPRS liable entities as
a matrix of five 'Processes' and five 'Cost Categories' within each
process (Table 1). The costs are further divided into 'startup' and
'ongoing'.

The analysis develops 8 'hypothetical companies', to represent the
9 sectors or industries whose energy, fugitive and industrial
process emissions are covered by the CPRS (whether directly or as
upstream or downstream liability). These sectors, and the estimated
number of firms within each sector, are summarised in Table 2. The
shaded sectors mainly comprise firms assumed to have NGERS
liability in GWA (2006). These are termed 'Group A'. The unshaded
sectors ('Group B') comprise firms which are not covered by NGERS -
or not covered in the same way as under CPRS - but would acquire a
new or much expanded liability under CPRS.

EY and the RIS (2008) estimate the total administrative costs in
each sector or industry by multiplying the number of companies in
that sector by the costs to each representative 'hypothetical'
company. Except in Manufacturing, where EY assumes a mix of about
two thirds 'smaller' and one third 'larger' firms, there does not
appear to be any adjustment for possible deviations from the
'hypothetical' firm for reasons of operational mix or company size.

The 'Mining' costs in the RIS are based on a hypothetical 'Large
upstream oil and gas company' (EY 2008, p23), whereas GWA (2008)
estimated that 106 of the facilities with emissions of greater than
25 kt CO2-e in 2005 were coal mines. As these will have much
simpler emissions and product flows, it is possible that the Mining
sector's total administrative cost will be significantly less than
estimated in the RIS[99]. As this sector accounts for about a fifth
of startup administrative costs and a third of the ongoing costs,
the impact of this assumption on total costs could be significant

Table 1: Matrix of administrative processes and cost categories

|Process |Cost Category |
| |Educati|Monitori|Reportin|Assuran|Other |
| |on, |ng |g, |ce | |
| |capacit|record |notifica| | |
| |y |keeping |tion | | |
| |buildin| | | | |
| |g | | | | |
|Carbon markets & |X |X |X |X |X |
|permit auction(a) | | | | | |
|Reporting & |X |X |X |X |X |
|Compliance(a) | | | | | |
|Tax & Accounting(a) |X |X |X |X |X |
|SAI(b) |X |X |X |X |X |
|EITE(c) |X |X |X |X |X |

Source: Derived by GWA from EY (2008).
(a) Applies to all forms.
(b) Additional administrative costs to 'Significantly Affected
Industries' associated with gaining access to free permits or other
concessions.
(c) Additional administrative costs to 'Emissions-Intensive Trade-Exposed
Industries' associated with gaining access to free permits or other
concessions.

Table 2: Total administrative costs by sector or industry

|Group| Sector or |Firms |Startup|Ongoing |Start|Ongoing|
| |industry | |$m |$m |up | |
|A |Electricity |56 |32.9 |15.4 |11.1%|14.3% |
| |Generation | | | | | |
|B |Gas retailers |24 |9.0 |7.0 |3.0% |6.5% |
|A |Additional |12 |4.8 |3.3 |1.6% |3.1% |
| |Fugitive | | | | | |
|B |Waste |120 |42.4 |7.0 |14.3%|6.5% |
|All |Total |767 |296.2 |107.3 |100.0|100.0% |
| | | | | |% | |
|A |Total |348 |165.3 |78.5 |55.8%|73.2% |
|B |Total |419 |130.9 |28.7 |44.2%|26.8% |

Source: Adapted by GWA from RIS (2008).
(a) 41 larger firms, 81 smaller firms.

Table 3: Analysis of administrative costs by process

| |Startup |Ongoing |Startup|Ongoing |
|Carbon markets & |100.1 |31.6 |34% |29% |
|permit auction | | | | |
|Reporting & Compliance|6.6 |55.7 |2% |52% |
|Tax & Accounting |170.1 |19.2 |57% |18% |
|SAI |5.2 |0.0 |2% |0% |
|EITE |14.3 |0.8 |5% |1% |
|Total |296.2 |107.3 |100% |100% |
|SAI+EITE |19.5 |0.8 |7% |1% |

Source: Derived by GWA from EY (2008).

Table 4: Analysis of administrative costs by cost category

| |Startup |Ongoing |Startup|Ongoing |
|Education/capacity |20.9 |8.9 |7% |8% |
|building | | | | |
|Monitoring/Record |0.9 |5.2 |0% |5% |
|Keeping | | | | |
|Other |274.4 |45.0 |93% |42% |
|Total |296.2 |107.3 |100% |100% |

Source: Derived by GWA from EY (2008) Shaded sectors correspond to cost
categories in (GWA 2006)

Table 5: Monitoring and reporting cost estimates, Group A

| |Number of |$M |$M/yr |$/yr |
| |Entities |startup |ongoing |entity |
| | | | |ongoing |
|>125 |93 |1.38 |1.38 |14839 |
|25-125 |260 |3.54 |3.54 |13615 |
|Total of above |353 |4.92 |4.92 |13938 |
|(GWA)(a) | | | | |
|Monitoring/Record |348 |0 |4.4 |12745 |
|Keeping (b) | | | | |
|Reporting/Notifica|348 |0 |0.3 |996 |
|tion (b) | | | | |
|Total of above |348 |0.0 |4.8 |13741 |
|(EY) (b) | | | | |

(a ) GWA (2006), Table 20.
(b) Derived by GWA from EY (2008) - See Table 2Error! Reference source
not found..

Table 6: Monitoring and reporting cost estimates, Group B

| |Number of |$M |$M/yr |$/yr/ |
| |Entities |startup |ongoing |entity |
| | | | |ongoing |
|Monitoring/Record |419 |0.9 |0.8 |1917 |
|Keeping (a) | | | | |
|Reporting/Notifica|419 |0.0 |0.6 |1365 |
|tion (a) | | | | |
|Total of above |419 |0.9 |1.4 |3282 |
|(EY) (a) | | | | |

(a) Derived by GWA from EY (2008) - See Table 2.

Table 3 summarises EY's cost estimates for the three process
categories that apply to all participants, one which applies to
Significantly Affected Industries (SAIs) and one to Emissions-
Intensive Trade-Exposed industries (EITEs). The SAI and EITE costs
are not in the same category as others, because they are borne
voluntarily by entities seeking to benefit from concessions made
available by Government. Presumably they will only do so if they
consider the benefits will outweigh the costs. Therefore these
costs should be reported as a distinct category, not as part of
total compliance costs. However, they comprise only 7% of startup
and 1% of ongoing costs, so the impact of their removal is small.

Table 4 analyses administrative costs by cost category rather than
process. The costs most closely relating to those previously
estimated by GWA for NGERS (GWA 2006) are Monitoring/Record Keeping
and Reporting/Notification. GWA (2006) estimated the costs of
monitoring energy use and associated emissions, and reporting
energy use and associated emissions. For 'Group A' firms, the
shaded costs in Table 4 should reflect only the additional costs
associated with extending pre-existing monitoring and reporting
systems to track permit purchases, holdings and sales, and
preparing annual compliance reports to the Australian Carbon Change
Regulatory Authority. The estimates of the pre-existing (NGERS) and
additional (CPRS) monitoring and reporting costs for Group A are
summarised in Table 5.

GWA estimated that there are 353 entities in this situation - the
RIS estimate (348) is virtually identical.[100] For these entities,
GWA estimated initial costs of $4.9m and on-going costs of $4.9m
per year. EY estimates no additional start up costs for this group
- which would be consistent with a pre-existing NGERS reporting
system - but assumes $4.8m of ongoing costs from additional
Monitoring and Reporting costs. In other words, EY estimates that
the CPRS would double annual Monitoring and Reporting costs for
firms already covered by NGERS. This estimate appears to be on the
high side.

Table 6 analyses Monitoring/Record Keeping and
Reporting/Notification costs for 'Group B' firms which have no
NGERS liability (or in the case of Waste, an NGERS liability that
may be calculated in substantially different ways), but acquire a
CPRS liability on account of their supply of fuels or Synthetic
Greenhouse Gases (SGG). For these entities, it is reasonable to
assume that all Monitoring/Record Keeping and
Reporting/Notification cost would be additional to NGERS costs.
EY's estimate of average ongoing costs is about $3,282 per entity
per year, compared with $13,741 per entity per year for 'Group A'
(Table 5). It is possible that this lower 'Group B' cost would be a
better indicator of the additional costs to 'Group A' entities, or
at least a realistic lower bound estimate.

However, Monitoring/Record Keeping and Reporting/Notification are
relatively minor cost categories.

'Education/Capacity Building' is described by EY (2008, p6) as
'cost incurred by a business in keeping abreast of regulatory
requirements'. It makes up 7% of total startup costs and 8% of
ongoing costs (Table 4).

'Assurance' comprises 'costs incurred by a business in gaining
assurance of its greenhouse gas emissions'. It makes up 0% of
startup costs and 44% of ongoing costs

The largest single cost category in Table 4 is 'Other', making up a
massive 93% of startup costs and 42% of ongoing costs. EY (2008,
p6) states: 'this may include legal, tax and accounting costs and
transaction costs associated with the purchase and acquittal of
permits.'

Elsewhere, EY (2008, p8) states that: 'The most significant
contributor to this start-up cost identified across all companies
was the cost associated with the management's review of
organisational strategy and assessment of the business implications
of the CPRS as well [as] financial modelling of potential cost pass-
through'.

'Assurance' is a specific area covered at length in the
Green Paper, which devotes section 5.3 to it and states
(p43):
Assurance under the Carbon Pollution Reduction Scheme
would be carried out in accordance with guidelines made
under the National Greenhouse and Energy Reporting Act
2007 and standards produced by the Australian Government's
Auditing and Assurance Standards Board.
All third-party assurance providers would be accredited to
ensure the development of a pool of properly trained and
qualified providers. The form and nature of accreditation
(including whether it is conducted by the Government or a
nongovernment body) would be determined after further
consultation, with a view to minimising compliance costs.
These assurance requirements are quite specific to the CPRS, and
there is no reason to question EY's estimates of the associated
costs, although in time it is likely that there would be economies
of scale from the same firms carrying out both general accounting
audits and CPRS assurance for the same firm at the same time.

However, the activities described under 'Education/Capacity
Building' and 'Other' appear to overlap with normal business
practice. All firms of the size covered by the CPRS would routinely
monitor taxation and other regulatory developments, refine their
accounting practices and modify business strategy according to
changing circumstances. Climate change has been a highly visible
public issue for at least two decades. In mid-2007 the previous
Government announced an intention to implement an emissions trading
scheme, and passed the NGERS legislation later in the same year. In
2007 the opposition (now the Government) also announced an
intention to implement an emissions trading scheme.

Many of the largest firms have obviously made considerable
investment already in assessing the impact of the CPRS on their
businesses, as evidenced by their submissions to Government at
various stages of the development of the CPRS. These are largely
sunk costs, which would not now be recovered even if the CPRS were
abandoned, and will continue to bring value as long as climate
change remains a significant issue.

EY estimates that 'Education' and 'Other' costs amount to $475,000
per firm (startup) and $90,000 per firm per year (ongoing) for
entities already covered by NGERS (Table 7). These are 50% and 70%
higher than the corresponding averages for Group B firms (Table 8).
It would be surprising if Group A companies would need to devote so
much more additional resources to 'Education/Capacity Building' and
'Other' activities solely as a result of the formal implementation
of the CPRS than Group B companies, who will have had much less
exposure to the issues.

Table 2: All CPRS administrative cost categories, Group A

| |Entit|$M |$M/yr|$/ent|$/yr/|Group|Group|
| |ies |start|ongoi|ity |entit|A/B |A/B |
| | |up |ng |start|y |start|ongoi|
| | | | |up |ongoi|up |ng |
| | | | | |ng |(a) |(b) |
|Education/capaci|348 |12.7 |4.5 |36507|12937|186% |122% |
|ty building | | | | | | | |
|Monitoring/Recor|348 |0 |4.4 |0 |12745|0% |665% |
|d Keeping | | | | | | | |
|Reporting/Notifi|348 |0 |0.3 |0 |996 |NA |73% |
|cation | | | | | | | |
|Assurance |348 |0 |42.2 |0 |12129|NA |1024%|
| | | | | |7 | | |
|Other |348 |152.6|27.0 |43856|77649|151% |181% |
| | | | |8 | | | |
|Total |348 |165.3|78.5 |47507|22562|152% |329% |
| | | | |5 |4 | | |
|Education + |348 |165.3|31.5 |47507|90586|153% |169% |
|Other | | | |5 | | | |

(a) Average $/entity startup costs for Group A firms compared with
average $/entity startup costs for Group B firms.
(b) Average $/entity ongoing costs for Group A firms compared with
average $/entity ongoing costs for Group B firms.

Table 3: All CPRS administrative cost categories, Group B

| |Entit|$M |$M/yr|$/ent|$/yr/|Group|Group|
| |ies |start|ongoi|ity |entit|B/A |B/A |
| | |up |ng |start|y |start|ongoi|
| | | | |up |ongoi|up |ng |
| | | | | |ng |(a) |(b) |
|Education/capaci|419 |8.2 |4.4 |19640|10566|54% |82% |
|ty building | | | | | | | |
|Monitoring/Recor|419 |0.9 |0.8 |2220 |1917 |NA |15% |
|d Keeping | | | | | | | |
|Reporting/Notifi|419 |0.0 |0.6 |0 |1365 |NA |137% |
|cation | | | | | | | |
|Assurance |419 |0.0 |5.0 |0 |11848|NA |10% |
|Other |419 |121.8|18.0 |29059|42879|66% |55% |
| | | | |9 | | | |
|Total |419 |130.9|28.7 |31245|68575|66% |30% |
| | | | |9 | | | |
|Education + |419 |130.0|22.4 |31023|53445|65% |59% |
|Other | | | |9 | | | |

(a) Average $/entity startup costs for Group B firms compared with
average $/entity startup costs for Group A firms.
(b) Average $/entity ongoing costs for Group B firms compared with
average $/entity ongoing costs for Group A firms.

Conclusions

EY estimates that 767 entities will be covered by the CPRS. About
45% are already liable for reporting and monitoring their emissions
under NGERS, but would acquire additonal liabilities under CPRS.
These are called 'Group A' in the present analysis. The other 55%
('Group B') are entities which are not covered by NGERS - or not
covered in the same way as under CPRS - but would acquire liability
under CPRS. Most of these are small fuel suppliers, synthetic
greenhouse gas importers and waste disposal entities.[101]

GWA makes the following observations with regard to EY's cost
estimates (relying solely on the documents EY (2008) and RIS
(2008)).

. Costs to SAI and EITE firms should be treated as a
separate sub-category of costs, since they would be
voluntarily incurred;

. The 'hypothetical company' used as the typical firm for
the Mining sector may not be fully representative of that
the sector; many of the firms in it could have simpler
emissions and product profiles;

. For nearly all cost categories, EY's estimates of the
average additonal costs to Group A entities are
significantly higher than for Group B entities, even
though Group A already participate in NGERS and Group B do
not. While some cost are related to complexity of
emissions or volume of permit holdings and transactions
(eg assurance), many could be largely fixed, irrespective
of the size of the firm. Therefore it is possible that
the averages for Group A firms could be substantially
closer to the estimates for Group B firms.

Table 9 illustrates the effects of adjusting SAI, EITE and Mining
costs and of moving the other Group A cost estimates closer to the
Group B costs estimates, for those cost categories where fixed (or
already sunk) costs are expected to be significant. This suggests
that there could be a lower bound of CPRS administrative costs
estimates that are 20% to 25% lower than the values reported in EY
(2008) and RIS (2008).

It is acknowledged that there may also be an upper bound that is
higher than the values reported. EY (2008, p13) states that 'Many
companies indicated significantly greater cost to the organisation
from the CPRS ... but the costs associated with these activities
were determined to be either substantive costs or cost incurred by
activities assumed to be over and above the base case assessment'.
This reinforces the value of presenting cost estimates as ranges
rather than as single values; GWA has attempted to estimate a lower
bound based on analysis of EY's reported data.

Whatever the administrative costs, it is useful to keep them in
perspective with the total costs of the CPRS, which will be
dominated by permit prices. Table 10 estimates the administrative
cost per tonne CO2-e emitted for groups of industries with roughly
similar emissions characteristics.

For the industries where CPRS liability will be dominated by direct
combustion, fugitive and industrial process emissions, the
administrative costs of compliance will be equivalent to $0.56/t
CO2-e (startup) and $0.23/t ongoing. For the fuel suppliers and
synthetic greenhouse gas suppliers, where CPRS liability is
determined by downstream sales, and the waste sector, the
administrative costs of compliance per tonne will be significantly
higher: $2.55 to 3.18/t CO2-e (startup) and $0.42 to 0.65/t
ongoing. This suggests that it would be valuable to work with these
sectors further to reduce participation costs.

Finally, Table 11 compares the projected administrative cost of
compliance with Treasury's projection of the permit costs of
compliance. This indicates that, even accepting EY's cost estimates
without modification, administrative costs will be only 2.8% to
3.9% of total compliance costs to firms at startup, falling to 0.5%
to 0.7% of compliance costs by 2020 and 0.2% of compliance cost by
2050. Furthermore it should be remembered that CPRS compliance
costs will be only a part of energy costs, and an even smaller part
of total operating costs.

Table 4: Sensitivity tests of variation of EY cost estimates

| |Startup|Ongoing|
| | | |
| |$m |$m/yr |
|EY Total estimates |296.2 |107.3 |
|Remove SAI, EITE |-19.5 |-0.8 |
|Reduce Mining Sector Costs by 25% |-13.7 |-9.6 |
|Reduce monitoring & reporting costs for |0.0 |-2.4 |
|Group A, by 50% (a) | | |
|Reduce ''education/capacity building' |-3.2 |-1.1 |
|costs, Group A, by 25% (b) | | |
|Reduce 'other' costs, Group A, by 25% |-38.2 |-6.8 |
|Adjusted total |221.8 |86.6 |
|Adjusted total compared with original EY |75% |81% |
|estimates | | |

(a) Group B average is 76% lower.
(b) Group B average is 35-40% lower.

Table 5: Administrative compliance cost per tonne CO2-e emitted

|NGGI |Mt CO2-e |$M startup |$M ongoing |$/t |$/t |
|sector |2006 |costs (a) |costs (a) |CO2-e|CO2-e|
| | | | | | |
| | | | |Start|Ongoi|
| | | | |up |ng |
|Energy, |424.7|95.2%|239.1|80.7%|97.2 |90.7%|0.56 |0.23 |
|Industry(b| | | | | | | | |
|) | | | | | | | | |
|SGHG |4.6 |1.0% |14.8 |5.0% |3.0 |2.8% |3.18 |0.65 |
|Waste |16.6 |3.7% |42.4 |14.3%|7.0 |6.5% |2.55 |0.42 |
| |445.9| 100%|296.2| 100%|107.3| 100%|0.66 |0.24 |

(a) Derived from Table 2.
(b) Includes industrial process emissions, with exception of SGHG.

Table 6: Administrative compliance cost compared with permit costs

| |Permit prices |$/t |$/t |$/t Tot|Ad/perm|Ad/perm|
| |$/t (a) | | | |it |it |
| |$/t | | | | | |
| |CPRS-5|CPRS-15|Startup|Ongoing|Admin |CPRS-5 |CPRS-15|
|Start |23 |32 |0.66 |0.24 |0.90 |3.9% |2.8% |
|2020 |35 |50 | NA |0.24 |0.24 |0.7% |0.5% |
|2050 |115 |158 | NA |0.24 |0.24 |0.2% |0.2% |

(a) Treasury 2008, Table 6.1.
(b) Table 10.

References

EY (2008) Input to Regulatory Impact Analysis on Administrative for
the Carbon Pollution Reduction Scheme, Final Report to the
Department of Climate Change, Ernst & Young, November 2008.

Green Paper (2008) Carbon Pollution Reduction Scheme Green Paper,
Commonwealth of Australia, July 2008.

GWA (2006) Costs and Benefits of a National Greenhouse and Energy
Reporting Framework, George Wilkenfeld and Associates with Energy
Strategies, for Department of the Environment and Heritage, March
2006.

GWA (2008) Work Order 1 to George Wilkenfeld & Associates: Report
to Department of Climate Change on Task 2 (document Work Order 1.1
- Report V2, 30 April 2008).

RIS (2008) Regulation impact statement: Carbon Pollution Reduction
Scheme (document Consolidated RIS 3 Dec.doc).

Treasury (2008) Australia's Low Pollution Future; The Economics of
Climate Change Mitigation, The Treasury, October 2008.

White Paper (2008) Carbon Pollution Reduction Scheme: Australia's
Low Pollution Future, Commonwealth of Australia, December 2008.

-----------------------
[1] Intergovernmental Panel on Climate Change Fourth Assessment Report,
Working Group I - The physical science basis, 2007, pp. 241-253.
[2] S Rahmstorf et al, Recent climate observations compared to
projections, Science, 316: 709. doi: 10.1126/science.1136843, 2007.
[3] E J.Rohling et al, High rates of sea-level rise during the last
interglacial period, Nature Geoscience, 1:38-42, 2008.
[4] CSIRO, Climate change scenarios for initial assessment of risk in
accordance with risk management guidance, 2006.
[5] National Emissions Trading Taskforce, Report of the Task Group on
Emissions Trading, p. 46.
[6] Due to the later release of this discussion paper, an extension to
the deadline for submissions on forestry aspects of the scheme was
granted.
[7] Under the Kyoto protocol, Australia has agreed to limit emissions to
108 per cent of 1990 levels in the 2008 to 2012 commitment period.
Australia is likely (but not certain) to meet this target even in the
absence of an emissions trading scheme (largely as a result of reductions
in land clearing in Australia). However, assuming that international
targets in following commitment periods reflect a desire to at least
stabilise emissions (the policy scenarios considered in section two are
associated with significant reductions in emissions), additional policy
action will be required to meet these targets.
[8] Department of Climate Change, Tracking to the Kyoto Target 2007:
Australia's Greenhouse Emissions Trends 1990 to 2008-2012 and 2020,
Commonwealth of Australia 2008.
[9] Australian Government's Initial Report under the Kyoto Protocol,
Update, 21 October 2008, available at
http://unfccc.int/national_reports/initial_reports_under_the_kyoto_protoco
l/ items/3765.php.
[10] The Australian Greenhouse Emissions Information System online
database, Commonwealth of Australia, 2008 (accessed 6 November 2008).
[11] Figures derived from Australia's national greenhouse gas emissions in
1990 and 2000 (from The Australian Greenhouse Emissions Information
System online database, Commonwealth of Australia, 2008 (accessed 6
November 2008)) and the Australia Bureau of Statistics' estimate of
Australia's population in those two years (from Australian Historical
Population Statistics, ABS catalogue item 3105.0.65.001).
[12] It is also worth noting that while Treasury estimates are not
strictly comparable with estimates from earlier studies (because the
estimates differ in terms of key assumptions such as the level of
business as usual emissions, the approach to global action and technology
timing), the cost estimates are broadly comparable and within the bounds
of previous studies.
[13] For instance, should the scheme impose obligations directly on the
emitter of greenhouse gases or should the obligation fall on upstream
suppliers (such as fuel producers) or downstream purchasers of goods.
[14] As discussed below, NGERS is the existing emissions reporting scheme
on which the emissions trading scheme builds. Under NGERS facilities
responsible for emissions of greater than 25 kt CO2-e/year (thousand
tonnes of carbon dioxide equivalent per year) are responsible for
reporting emissions and as a result this level of emissions forms a
natural threshold for the emissions trading scheme.
[15] Australian Government, Australia's low pollution future, the
economics of climate change, page 140.
[16] Australian Government, Australia's low pollution future, the
economics of climate change, page 146.
[17] Where businesses have abatement opportunities that are more cost
effective than the cost of purchasing permits, they will undertake this
abatement. For businesses where the cost of abatement is higher than the
cost of purchasing permits, they will purchase permits rather than
undertake abatement. As a result, only the cheapest abatement options
should be pursued under an emissions trading scheme.
[18] The costs to particular industries of purchasing permits (and
associated reductions in output/demand for those industries) are driven
more by the choice of scheme cap (which is related to the trajectory)
than the coverage of different sectors. The choice of scheme cap will
determine the amount of abatement that must occur under the CPRS. The
larger the amount of abatement required, the more costly permits will be
under the scheme (because more expensive abatement options will need to
be pursued) and the more significant the costs associated with purchasing
permits will be. Given a particular scheme cap, the coverage of
particular sectors will have limited influence on the size of these
costs, although it will influence the distribution of the costs. Removing
particular sectors from the scheme effectively shifts the burden for
abatement to other covered sectors. Indeed, as discussed above, limiting
the coverage of the scheme is likely to increase the costs of meeting a
particular abatement goal as it removes a set of potentially cost
effective abatement opportunities from the scheme.
[19] This accounts for a large majority of greenhouse gases. However,
there are some synthetic greenhouse gases which are not covered by the
Kyoto protocol. These represent a very minor share of global emissions
and while they will not be covered by the emissions trading scheme, they
will be covered by related legislation to avoid substitution toward these
gases.
[20] National Greenhouse Gas Inventory 2006, Department of Climate Change.
[21] Entities responsible for reporting emissions have a choice of four
methods under the NGERS legislation. The first uses national averages to
calculate emissions while other methodologies use site specific
estimation techniques.
[22] This number is also likely to include emissions from industrial
processors (other than synthetic greenhouse gas importers).
[23] National Greenhouse Gas Inventory 2006, Department of Climate Change.
[24] National Greenhouse Gas Inventory 2006, Department of Climate Change.
[25] This estimate assumes that there are 72 coal mining companies (who
operate the 120 mines) which are represented by hypothetical company A
and 30 gas supply companies (who operate the 50 fugitive emissions
sources) and are represented by hypothetical company G. It also includes
the 12 fugitive gas companies who are not captured elsewhere in the
scheme (represented by company A). This hypothetical company has
emissions from a number of sources in addition to fugitive emissions and
it is expected the 'average' pure fugitive emitter would incur fewer
compliance costs.
[26] National Greenhouse Gas Inventory 2006, Department of Climate Change.
[27] National Greenhouse Gas Inventory 2006, Department of Climate Change.
[28] National Greenhouse Gas Inventory 2006, Department of Climate Change.
[29] Hyder Consulting, Review of Methane Recovery and Flaring from
Landfills, October 2007.
[30] Hyder Consulting, Review of Methane Recovery and Flaring from
Landfills, October 2007.
[31] Hyder Consulting, Australian Carbon Pollution Reduction Scheme -
Assessment of Landfill Legacy Issues (forthcoming - this consultants
report will be published on the Department of climate change website
following the release of the white paper)
[32] That is, if the Government provides permits for the total build up of
carbon in the forest and then requires liable entities to return
(surrender) permits when the forest is felled or lost to fire and that
carbon is emitted.
[33] It is also instructive to note that a key consideration when
determining the types of international units Australia will allows in its
scheme is the level of confidence Australia has that the international
units represent truly additional abatement.
[34] While perceptions of non compliance should be linked to actual levels
of non-compliance, this need not be the case. Importantly Government
actions to ensure compliance can improve perceptions of compliance with
the scheme even in the absence of widespread non-compliance. For
instance, even if there were widespread compliance with the scheme, the
absence of an auditing mechanism could lead some stakeholders to question
the accuracy of reported emissions. This would have impacts on confidence
with the scheme even in the absence of widespread non-compliance.
[35] This is likely to be an over estimate of the compliance costs for
this option. The per business costs were estimated in the context of
assurance for very large emitters (over 125 kt CO2-e/year). The costs of
obtaining a third party audit for smaller emitters (the bulk of the 1000
liable entities) are likely to be lower than this amount.
[36] The Kyoto Protocol establishes quantified emissions targets for
industrialised countries and countries with economies in transition
(Annex I Parties) in the form of an absolute emission cap for each Party
for the period 2008-12 (the commitment period). Australia's target is
108 per cent of 1990 emissions. The Kyoto Protocol also provides a
framework for Parties to acquire units from other countries and use them
towards meeting their emissions targets, via emissions trading or two
project based mechanisms, the Clean Development Mechanism and the Joint
Implementation Mechanism.
[37] Administrative allocation occurs where permits are allocated by the
Government (or Regulator) to liable entities for free, using some agreed
formula for example on the basis of historical emissions. This occurred
in the European Union Emissions Trading Scheme.
[38] R Garnaut, The Garnaut Climate Change Review: Final report, Cambridge
University Press, 2008.
[39] National Emissions Trading Taskforce, Possible design for a national
greenhouse gas emissions trading scheme: Final framework report on scheme
design.
[40] Regional Greenhouse Gas Initiative, http://www.rggi.org.
[41] Directive 2003/87/EC of the European Parliament and of the Council of
13 October 2003 establishing a scheme for greenhouse gas emission
allowance trading within the Community and amending Council Directive
96/61/EC.
[42] New Zealand Government, Framework for a New Zealand Emissions Trading
Scheme.
[43] See for instance McKibbin, W. and Wilcoxen, P. (2007) 'Two issues in
carbon pricing: timing and competitiveness', Working Papers in
International Economics, April, No. 1.07, McKibbin, W. and Wilcoxen, P.
(2006), 'A credible foundation for long term international co-operation
on climate change', Working Papers in International Economics, June, No.
1.06, Lowy Institute for International Policy, Sydney; and also McKibbn,
W. (2006), 'Why Australia should take early action on climate change',
Lowy Lunch Lecture, December 13. Available at www.lowyinstitute.org, .
[44] Bidders will be restricted to parcel sizes of no more than 25 per
cent of the total number of permits sold at each auction. As there are to
be 16 auctions, (section 9.5.8 refers) this implies bids of no larger
than around 1.6 per cent of total permits issued for a given vintage. The
advantage of imposing a maximum parcel size is that it reduces the
potential for large entities to monopolise the market for permits - which
stakeholders raised as an important concern. The trade-off is that this
is likely to inhibit the flexibility of the market. However, around
1.6 per cent should be sufficient, given that the largest single entity
is estimated to account for around 3.5 per cent of total emissions. This
would mean that the largest entity could buy all its requirements at just
three auctions.
[45] Eligible international units are units issued under the international
Kyoto framework. Carbon pollution permits are domestic compliance units
issued under the Australian scheme by the scheme regulator. Domestic
scheme participants can use eligible international units as substitutes
for carbon pollution permits to meet domestic scheme obligations.
[46] Prime Ministerial Task Group on Emissions Trading, Report of the
Prime Ministerial Task Group on Emissions Trading.
[47] National Emissions Trading Taskforce, Possible design for a national
greenhouse gas emissions trading scheme: Final framework report on scheme
design.
[48] R Garnaut, The Garnaut Climate Change Review: Final report, Cambridge
University Press, 2008.
[49] New Zealand Government, The Framework for a New Zealand Emissions
Trading Scheme, 2007. In 2008, the New Zealand Parliament passed
emissions trading legislation. Following the change of Government, the
operation was suspended, but the current Government remains committed to
a modified emissions trading scheme.
[50] Directive 2003/87/EC of the European Parliament and of the Council of
13 October 2003 establishing a scheme for greenhouse gas emission
allowance trading within the Community and amending Council Directive
96/61/EC.
[51] R Garnaut, The Garnaut Climate Change Review: Final report, Cambridge
University Press, 2008.
[52] Proposal for a Directive of the European Parliament and of the
Council 2008/0013 of 23 January 2008 amending Directive 2003/87/EC.
[53] European Commission, Directorate General for Environment, Review of
the EU Emissions Trading Scheme - survey highlights, survey conducted by
McKinsey and Company and Ecofys, November 2005.
[54] New Zealand Government, The Framework for a New Zealand Emissions
Trading Scheme, September 2007.
[55] National Emissions Trading Taskforce, Possible Design for a National
Greenhouse Gas Emissions Trading Scheme: Final Framework Report on Scheme
Design, 2007.
[56] Prime Ministerial Task Group on Emissions Trading, Report of the Task
Group on Emissions Trading, Commonwealth of Australia, 2007.
[57] R Garnaut, The Garnaut Climate Change Review: Final report, Cambridge
University Press, 2008.
[58] R Garnaut, The Garnaut Climate Change Review: Final report, Cambridge
University Press, 2008.
[59] Proposal for a Directive of the European Parliament and of the
Council 2008/0013 of 23 January 2008 amending Directive 2003/87/EC.
[60] It is expected that permits and permit related derivatives will be
traded on existing exchanges such as the Australian Stock Exchange.
[61] National Emissions Trading Taskforce, Possible Design for a National
Greenhouse Gas Emissions Trading Scheme: Final Framework Report on Scheme
Design, 2007.
[62] R Garnaut, The Garnaut Climate Change Review: Final report, Cambridge
University Press, 2008.
[63] New Zealand Government, The Framework for a New Zealand Emissions
Trading Scheme, September 2007. In 2008, the New Zealand Parliament
passed emissions trading legislation. Following the change of Government,
the operation was suspended, but the current Government remains committed
to a modified emissions trading scheme.
[64] Prime Ministerial Task Group on Emissions Trading, Report of the Task
Group on Emissions Trading, Commonwealth of Australia, 2007.
[65] Directive 2003/87/EC of the European Parliament and of the Council of
13 October 2003 establishing a scheme for greenhouse gas emission
allowance trading within the Community and amending Council Directive
96/61/EC.
[66] Proposal for a Directive of the European Parliament and of the
Council 2008/0013 of 23 January 2008 amending Directive 2003/87/EC.
[67] AD Ellerman and PL Joskow, The European Union's Emissions Trading
Scheme in Perspective, PEW Center on Global Climate Change, 2008.
[68] Directive 2003/87/EC of the European Parliament and of the Council of
13 October 2003 establishing a scheme for greenhouse gas emission
allowance trading within the Community and amending Council Directive
96/61/EC.
[69] Regional Clean Air Markets: http://www.aqmd.gov/RECLAIM/reclaim.html.
[70] National Emissions Trading Taskforce, Possible Design for a National
Greenhouse Gas Emissions Trading Scheme: Final Framework Report on Scheme
Design, 2007.
[71] Office of the Renewable Energy Regulator,
http://www.orer.gov.au/index.html.
[72] NSW Greenhouse Gas Reduction Scheme,
http://www.greenhousegas.nsw.gov.au
[73] ACT Greenhouse Gas Abatement Scheme:
http://www.icrc.act.gov.au/actgreenhousegasabatementscheme.
[74] Prime Ministerial Task Group on Emissions Trading, Report of the Task
Group on Emissions Trading, Commonwealth of Australia, 2007.
[75] National Emissions Trading Taskforce, Possible Design for a National
Greenhouse Gas Emissions Trading Scheme: Final Framework Report on Scheme
Design, 2007.
[76] Prime Ministerial Task Group on Emissions Trading, Report of the Task
Group on Emissions Trading, Commonwealth of Australia, 2007.
[77] W McKibbon and P Wilcoxen, A Credible Foundation for Long Term
International Cooperation on Climate Change, Lowy Institute for
International Policy Working Papers in International Economics, No 1.06,
June 2006.
[78] Greenhouse Gas Reduction Scheme, http://www.greenhousegas.nsw.gov.au.
[79] ACT Greenhouse Gas Abatement Scheme:
http://www.icrc.act.gov.au/actgreenhousegasabatementscheme.
[80] Queensland 13% Gas Scheme:
http://www.dlme.qld.gov.au/Energy/13percentgas.cfm.
[81] Directive 2003/87/EC of the European Parliament and of the Council of
13 October 2003 establishing a scheme for greenhouse gas emission
allowance trading within the Community and amending Council Directive
96/61/EC.
[82] New Zealand Government, The Framework for a New Zealand Emissions
Trading Scheme, September 2007.
[83] Office of the Renewable Energy Regulator,
http://www.orer.gov.au/index.html.
[84] Greenhouse Gas Reduction Scheme, http://www.greenhousegas.nsw.gov.au.
[85] While permits might be considered to be CGT assets, because of the
anti-overlap rules in sections 118 to 120 of the Income Tax Assessment
Act 1997, a CGT gain or loss is essentially excluded to the extent that
the CGT event also results in an amount being included in assessable
income under another (non-CGT) provision.
[86] Australian Government, Australia's low pollution future, the
economics of climate change, page 176 (price increase associated with the
'minus 5' scenario.
[87] Australian Government, Australia's low pollution future, the
economics of climate change, page 190 (price increase associated with the
'minus 5' scenario.
[88] In the national electricity market, the price of electricity in any
period (each five minute interval) is set by the marginal generator (the
last generator dispatched). While the price bid by the marginal generator
is likely to increase to cover the additional costs of purchasing
permits, it is likely that they will only increase their bid to just meet
their own permit liabilities. Many generators higher in the merit order
(ie who bid a lower price than the marginal generator and are dispatched
'before' the marginal generator) also receive the price bid by the
marginal generator. These generators will typically have higher levels of
emissions than the marginal generator (they are more likely to be base
load coal fired generators with lower marginal costs). As a result, the
price increase generated by the change in bidding behaviour of the
marginal generator is unlikely to fully cover the cost increase for the
more emissions intensive generators.
[89] As discussed elsewhere in this RIS (see for example chapter 3), a
broad based emissions trading scheme (including international linking)
allows abatement to occur in the sectors and regions where it is most
cost effective. This should minimise the costs associated with meeting
any given abatement objective.
[90] At an assumed carbon price of $23 per ton (the initial estimated
permit price under the minus 5 scenario in the Treasury modelling), an
emitter on the 25 kt CO2-e/year threshold would have a yearly liability
of $575 000. Their turnover would have to be significantly higher than
this figure.
[91] 20 and 22 per cent are the price rises associated with the minus 5
and minus 15 scenarios in the Treasury modelling.
[92] It is expected that there would be limited impediments to cost pass
through for small businesses. While increases in price would result
reductions in demand these are expected to be relatively limited. With
the exception of industries such as coal mining, aluminium production and
coal fired electricity generation (which are unlikely to contain any
small businesses), Treasury modelling suggests that most industries would
face relatively small reductions in output by 2050. For instance, the
industry that is projected to incur the greatest reduction in demand
(relative to the reference scenario) and is likely to contain small
businesses is the sheep and cattle industry and the reduction in output
for this industry is expected to be around 6.7 and 10.2 per cent (for the
minus 5 and minus 15 scenarios). While output is lower than in the
reference scenario, it is worth noting that output (in the minus
5 scenario) is still predicated to be 88 per cent higher than in the
2008.
[93] These permit prices are based on Treasury modelling of the minus 5
and minus 15 scenarios.
5[94] This approach was agreed with the DCC for the hypothetical companies,
but in reality this approach is unlikely to be representative behaviour
for liable entities.
6[95] For a number of real companies, these contract review costs will be
significant and for a few companies very significant; costs will be
incurred through internal review and external legal review
7[96] Relative actual costs will vary considerably with the complexity of
compliance requirements.
8[97] Note: The VCEC model usually deals with regulations that require less
staff time and is therefore calculating staff costs in terms of hours.
As CPRS will require greater staff hours, we have used days as the
appropriate measure.
9[98] Average wage data for employee type was sourced from
MyCareer.com.au on Friday 14th November
http://content.mycareer.com.au/salary-centre/legal/
http://content.mycareer.com.au/salary-centre/property-real-estate/admin-
office-support-reception/
http://content.mycareer.com.au/salary-centre/accounting/financial-
management-accounting
http://content.mycareer.com.au/salary-centre/executive/engineering-
manufacturing
[99] It is recognised that many liable firms will have more than one
liable facility.
[100] GWA (2006) actually estimated ongoing costs, and assumed these would
be doubled in the startup year.
[101] While waste disposal facilities are covered under NGERS, the mode of
coverage was not envisaged in the original cost studies carried out by
GWA 2006). Lower emissions triggers and different accounting treatments
are now proposed in the CPRS (eg 10 kt CO2-e in some instances rather
than 25 kt CO2-e).

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