Draft CPRS legislation – implications for the oil & gas industry

Draft CPRS legislation

On 10 March 2009 the Federal Government released the draft exposure legislation to implement its Carbon Pollution Reduction Scheme (CPRS), (Draft CPRS legislation).¹ The Draft CPRS legislation follows the government’s White Paper, released on 15 December 2008, and largely reflects the policy positions set out in the White Paper. The Carbon Pollution Reduction Scheme Bill 2009 (Cth) (CPRS Bill) is the main component of the Draft CPRS legislation.

Submissions and lobbying

The Federal Government will be accepting submissions on the Draft CPRS legislation before 14 April 2009, meaning there is very limited time for stakeholders to digest the ramifications of the Draft CPRS legislation and lobby for changes.

Despite the Draft CPRS legislation largely reflecting the White Paper, recent political discussions surrounding the CPRS indicate that the government will need to negotiate on the CPRS to have it passed through the Senate, and therefore it may need to concede on various matters.

Key commercial implications

Key commercial implications of the Draft CPRS legislation for the oil & gas industry include:

1. confirming the medium-term target, Australian emissions units (AEUs) price cap and that there will be no quantitative limit on the use of ‘eligible international units’, means there is now much greater certainty regarding the likely price impacts of the CPRS. Therefore mitigative measures can be explored and implemented (including eligible international units and Australian forestry AEUs)
2. LNG production will receive Emissions-Intensive Trade-Exposed (EITE) compensation (confirmed in the EITE guidance paper released in February 2009 (EITE Guidance Paper))
3. the direct obligation (and therefore compliance burden) for fossil fuel emissions will be initially imposed on upstream fossil fuel importers, producers and suppliers. In some circumstances this obligation will or can be transferred through an Obligation Transfer Number (OTN) process. Where the OTN process is not used and upstream entities bear the direct obligation themselves this cost will need to be dealt with commercially
4. CCAF funding may be available to the oil & gas industry, and
5. there is funding available for CCS activities.

It is critically important to ensure the CPRS legislation is correctly drafted to achieve industry’s goals.

The oil & gas industry will also need to be involved with the government’s EITE process, as detailed in the EITE Guidance Paper.

Carbon pricing

Targets

The Draft CPRS legislation includes as an object of the legislation the long-term and medium-term emissions reduction targets previously stated by the Federal Government of:

1. a 60 per cent reduction against 2000 emission levels by 2050, and
2. a 5–15 per cent reduction against 2000 emission levels by 2020.

AEUs price cap

The Draft CPRS legislation confirms that there will be a price cap on the price of AEUs in the first five years of the CPRS. The price cap will be $40 per tonne CO₂e at commencement of the CPRS, rising to $43 in 2011, $46.23 in 2012, $49.69 in 2013 and $53.42 in 2014.

Permits will be available at this price direct from the government in the first five years of the scheme, between 31 October (the emissions reporting deadline) and 15 December (the permit surrender deadline). Unlike ‘ordinary’ AEUs, ‘fixed price’ AEUs will be incapable of being banked or traded, and they will be automatically surrendered on their acquisition.

Eligible international units

The Draft CPRS legislation confirms that there will be no quantitative restrictions on the use of eligible international units² for compliance in the CPRS.

The market for these credits, particularly CERs under the CDM program, is developed and largely compared to Australia’s total emissions and will operate as a further ceiling on the carbon price in Australia. If the price for purchasing AEUs (either direct from the Australian Government in auctions, from forestry producers or on the secondary market) rose above the price of eligible international units then businesses could simply purchase the eligible international units instead.

In recent times, prices for CERs on both the primary and secondary market have been depressed, in part due to stagnating EU demand as emitters offload permits that are not required, but primarily as a result of the global financial crisis. Kyoto credits have recently traded at approximately AUD$17.67(€9)/tCO₂e on the secondary market, or about AUD$11.78(€6)-AUD$15.70(€8)/tCO2e direct from accredited projects. However, the CER price can be expected to rise over time as demand increases and opportunities to source credits directly becomes more difficult.³

Australian forestry AEUs

Australian forestry operators can opt into the CPRS and be issued with AEUs in respect of the sequestration they produce. This may therefore be another source of lower cost abatement for oil and gas industry emitters with CPRS exposure.

Likely carbon price

The Commonwealth Department of Treasury’s modelling, released on 30 October 2008, predicted the carbon price under both five per cent and 15 per cent reduction targets (the extremities of the White Paper medium-term target), in models called CPRS-5 and CPRS-15. This modelling was based on Australia’s action taking place within a simple multi-stage global policy framework, where Australia and other developed countries take comparable action from 2010, and developing countries gradually adopt emission reduction obligations from 2015 to 2025. The following table presents Treasury’s predicted carbon price under this modelling:

However, this modelling was undertaken prior to the current global financial crisis breaking and its modelling and results do not take into account these changed conditions.

The indications are that the carbon price at commencement of the CPRS on 1 July 2010 will more closely align with the CPRS-5 modelling than CPRS-15, or be even lower in line with prevailing CER prices.

Coverage and point of obligation

The Draft CPRS legislation indicates that the CPRS will apply to the Australian oil & gas industry as follows.

Fugitive emissions from natural gas pipelines and oil & gas production

CPRS obligations will apply to entities that have operational control of a facility that has direct fugitive emissions of 25kT CO₂e pa or more. The precise detail of this coverage is left to amendments to be proposed to the National Greenhouse and Energy Reporting Regulations 2008 (Cth) (NGER Regs).

Domestic emissions from using fossil fuels

Netting-out arrangements

The Draft CPRS legislation provides for a netting-out arrangement for ‘eligible upstream fuels’ (including natural gas, ‘liquid petroleum fuels’, LNG and LPG), and provides for an administrative transfer mechanism – an Obligation Transfer Number (OTN) – to enable CPRS obligations to be transferred between entities, at the same time that fuels are supplied, down the supply chain.

The starting point under the Draft CPRS legislation is that the initial importer/producer/supplier will be liable under the CPRS for the emissions from the final use of eligible upstream fuels (ie final combustion emissions).

The Draft CPRS legislation then provides that the following entities must use an OTN to assume CPRS liability from the upstream supplier for final use emissions:

• large users of eligible upstream fuels other than liquid petroleum fuels (ie entities with operational control of a facility that emits 25kT CO₂e pa or more from combustion of a single fuel)
• retailers of natural gas
• LPG marketers, and
• users of LPG as a feedstock.

The Draft CPRS legislation then further provides that the following entities may use an OTN to assume CPRS liability from the upstream supplier for final use emissions and directly manage their CPRS liabilities:

• certain entities that use large amounts (to be specified in the CPRS regulations) of eligible upstream fuels or who are approved persons (as approved by the proposed Australian Climate Change Regulatory Authority)
• entities that package eligible upstream fuels for use otherwise than by combustion
• entities that use eligible upstream fuels in manufacturing a product otherwise than by way of combustion
• entities undertaking the transformation of eligible upstream fuels into another type of eligible upstream fuel, and
• entities carrying on the business of exporting or re-supplying prescribed LPG or types of prescribed eligible upstream fuel.

Various details for these matters are left to the CPRS regulations.

Whether these entities choose to assume direct responsibility for the CPRS liability of the fuels they use will depend on their particular circumstances.

Where CPRS liability is transferred through the OTN process then the entity assuming the CPRS liability will be responsible for acquitting permits directly to the Government in respect of final use emissions for the product supplied under the OTN process, not the upstream supplier. Therefore the OTN mechanism will have commercial ramifications for the sale of eligible upstream fuels, where:

• if the upstream supplier holds the CPRS liability then the sale price will incorporate that CPRS price, and
• if a purchasing entity assumes CPRS liability then they will incur direct CPRS costs themselves and consequently the sale price will not incorporate the CPRS price.

The Draft CPRS legislation does not outline the full mechanics of the OTN process and we therefore expect that further information will be contained in the CPRS regulations or outlined in Government policy. The Government has previously stated that it expects to refine the administration of netting out arrangements in consultation with stakeholders following the release of the Draft CPRS legislation.

The following legend and diagrams were presented in the White Paper and assist to explain the OTN process. They have been adapted as appropriate in line with the Draft CPRS legislation.

Natural gas

Liquid petroleum fuels

The White Paper provided that as a transitional measure the Federal Government would initially reduce the fuel tax on transport fuels, to offset the increase in price due to the CPRS. In respect of LPG, CNG and LNG (which are not subject to fuel tax) a CPRS fuel credit would be available to ensure that they maintain their relative price and competitiveness against other transport fuels. The CPRS fuel credit would be available:

1. for three years on LPG, consistent with the standard transport fuel tax cuts, and
2. for one year on CNG and LNG, consistent with the regime for heavy on-road transport where those fuels are primarily used,

and then be reviewed after that time.

However, the Draft CPRS legislation does not address these proposed fuel tax and credit matters. It is therefore expected that these matters will be effected through subsequent amendments to the necessary legislation (for example the Excise Act 1901 (Cth), the Excise Tariff Act 1921 (Cth), the Customs Act 1901 (Cth) and the Customs Tariff Act 1995 (Cth)).

LPG

Products used for feedstock/manufacturing

International use

The White Paper stated that emissions that occur outside of Australia (for example from LNG exported), or for international voyages (ie international shipping or aviation fuel), will not be covered by the CPRS. The Draft CPRS legislation does not address the use of fuel for international voyages, it is noted in the commentary that the Government is currently developing separate measures to address these emissions.

CCS

Draft CPRS legislation treatment

There is no express treatment of CCS in the Draft CPRS legislation and therefore how it will be treated under the CPRS (for example if a government granted injection licence will be required) remains slightly uncertain. However, it appears that:

• emissions that are captured and permanently stored do not fit within the definition of ‘emission’ in the CPRS Bill and National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act), because they are not ‘released into the atmosphere’ as required by that definition, and
• therefore any emissions which have been captured and stored are not ‘emissions’ from a facility for the purposes of the Draft CPRS legislation and thus will not give rise to a CPRS liability.

Nevertheless, it is likely (but still dependent on amendments to the NGER Regs) that the operator of a CCS facility will be liable for any fugitive emissions from the operation of the facility, including leakages from the facility, as they would be emissions released into the atmosphere.

In practice this means that a natural gas processer will not be liable under the CPRS in respect of reservoir emissions that are sequestered, but a liability will arise (and permits would need to be acquired and surrendered) in respect of any fugitive emissions. The CPRS will therefore provide a commercial driver for CCS.

Legislative developments

CCS regimes have been enacted at a state and federal level in Australia. The Offshore Petroleum Amendment (Greenhouse Gas Storage) Act 2008 (Cth) commenced in November 2008, and the Federal Government is currently consulting with stakeholders regarding the regulations which will be made under that Act. The first CCS acreage release is expected to occur by the end of March 2009. Onshore legislation has also been passed in Victoria and Queensland.

Compensation & funding

Emissions-Intensive Trade-Exposed (EITE) compensation

The Draft CPRS legislation does not deal with the proposed EITE program in any specific detail, which has been left for the subsequent CPRS regulations. The commentary to the Draft CPRS legislation provides that the EITE program will follow the White Paper. The following White Paper table summarises the EITE assistance program as detailed in the White Paper.

In addition to the information in this table, the White Paper also indicated that the trade exposure of activities will be assessed on one or the other of the following bases:

1. a trade share (defined as the ratio of the value of imports and exports to the value of domestic production) greater than 10 per cent in any one of the years 2004–05, 2005–06, 2006–07 or 2007–08, or 
2. a demonstrated lack of capacity to pass through costs due to the potential for international competition.

Summary of EITE assistance

Further information has been provided since the White Paper in the EITE Guidance Paper released in February 2009, which in particular outlines the process the Federal Government will follow in determining and finalising the details of the EITE program and how entities should participate in that process.

The Guidance Paper provided that a number of production processes would be exempt from the preliminary EITE assessment stage and would proceed directly to a formal assessment of eligibility, including relevantly for the oil and gas industry LNG production, methanol production, petroleum refining and ethanol production.

One particular matter to note is that EITE assistance will attach to certain defined ‘activities’, rather than to entire production processes and therefore even if entities conduct such activities it is possible that aspects of their business and emissions will not be compensated. Also, compensation will be provided on the basis of industry wide activity averages, rather than on a company or project specific basis. Therefore some entities may receive a greater or smaller level of compensation against their actual emissions.

The EITE assistance program remains a controversial component of the CPRS and debate continues, including in respect of the level of compensation and the carbon productivity contribution.

Climate Change Action Fund (CCAF)

The White Paper stated that the CCAF will be a $2.15 billion fund available over five years (from 1 July 2009) to smooth the transition for certain businesses, community sector organisations, workers, regions, and communities to an operating environment that includes a price on carbon. A priority of the CCAF will be businesses that are ineligible for other forms of assistance associated with the CPRS, or receive the lower level of EITE assistance. Therefore the CCAF will be available to LNG and natural gas producers if they receive the lower level of EITE assistance.

The CCAF will have four streams, of which the relevant stream for the oil and gas industry is stream 2. It will provide grants and incentives for businesses to invest in energy efficiency projects and low emissions technologies, processes and products. This stream will have $1.4 billion available over five years. In particular there will be a sub-program for ‘Innovation in Climate Change’, being for competitive grant funding to contribute to the cost of innovative low emission technologies, production methods, supply-chain improvements or products, and energy savings projects with long pay back periods. The competitive funding round will begin in late 2009. It will complement the Government’s existing range of energy technology specific funds.

Minimal information has been provided as to how to access the CCAF.

CCS

Federal Government assistance for investment in CCS is currently being offered through:

• the National Low Emissions Coal Initiatives (NLECI), with $500 million available over eight years, with the intention to generate $1.5 billion through partnerships with industry, focused towards coal related CCS technological development, and
• the Australian Global Carbon Capture and Storage Institute (AGCCSI), up to $100 million per year will be contributed to funding CCS projects.

Notably the Federal Government’s rhetoric around these initiatives is primarily focused towards coal related CCS (and entirely in the case of the NLECI) and not the storage of CO₂ liberated through the LNG production process.

CCS is not currently recognised under the CDM mechanism despite Australia’s attempts at recent UN conferences. Increased industry support may assist. CDM recognition would pave the way for funding for CCS projects in developing countries, and therefore significantly increase CCS R&D investment, by allowing those projects to generate CERs. Without this funding there are few commercial drivers for CCS projects in developing nations.

National Greenhouse and Energy Reporting System (NGERS)

The Draft CPRS legislation outlines how the CPRS will rely on the NGERS for the measurement and reporting of liable emissions. The NGERS is already in force and therefore this re-emphasis of its significance raises the issue of whether parties that have obligations under it are complying or will be in a position to comply.

The NGERS will require the ‘controlling corporations’ of corporate groups that exceed the set thresholds to register and report their emissions, energy production and energy consumption in respect of the 2008/2009 financial year. It contains provisions that particularly apply to the treatment of joint venture information.

The following diagram depicts the relevant thresholds and deadlines for registration and reporting.

Next steps

The Federal Government’s indicated timetable for implementing the CPRS and related matters is set out below (with EITE and NGERS steps included).

The Rudd Government intends to have the CPRS legislation through Parliament by June 2009. However, the Federal Government does not control the Senate. In the Senate the Government will need the support of either the Opposition Liberal and National Parties (the support of the Liberals alone would be sufficient), or all minor parties (the Greens, and the independents from Victoria (Fielding) and South Australia (Xenophon)). The initial reaction of the Greens has been negative to the medium-term target and EITE and coal power station compensation. The Opposition has stated it will not support the proposed CPRS as currently formulated, preferring to delay introduction of an emissions trading scheme until global economic conditions improve (ie not before 2011 or 2012). The Nationals have been stronger in their opposition to the CPRS than the Liberals.

The Opposition and Greens agreed terms of reference for a Senate Select Committee inquiry into the CPRS, scheduled to report by 14 May 2009. The Senate Standing Committee on Economics will also conduct an inquiry into the CPRS, to report by 14 April 2009.

Therefore, there will continue to be scope to lobby in respect of the CPRS design.

Parliament is scheduled to rise for the winter recess on 25 June 2009.

Timetable

How Freehills can help

Climate change issues are diverse and complex and span the range of commercial legal issues. Our Climate Change team is uniquely placed to supply the breadth and depth of the legal services required by this evolving area of policy and law.

Our team is fully informed by overseas and local developments. It offers legal services that are alert to the commercial ramifications of these developments and that are coordinated across all the relevant areas of law including: environmental, banking and finance, corporate, infrastructure development and intellectual property. Our team’s legal services cover the full range of compliance, contractual and market-related issues.

Compliance

Our legal services on compliance include:

• Advising on and assisting with submissions in respect of the Draft CPRS legislation
• Advising on establishment and management of National Greenhouse and Energy Reporting System issues, particularly under existing and proposed unincorporated and incorporated joint ventures
• Advising on establishment and management of data systems consequent on commencement of the CPRS and the rationalisation of existing climate change and renewable energy regulatory regimes
• Assisting with the emissions-intensive, trade-exposed (EITE) compensation data collection process (commencing in early 2009)
• Advising concerning disclosure obligations under the Corporations Act 2001 (Cth) and ASX listing rules and related Trade Practices issues (and other corporate disclosure issues)
• Advising on compliance issues under Renewable Energy Target scheme and the amendments proposed to it 
• Advising on the climate change issues involved in the environmental impact assessment of new projects, at local, state and Commonwealth levels, and
• Advising on other climate change-related regulations affecting business, such as building regulations and energy efficiency requirements.

Contract documentation

Our legal service on contract documentation include:

• Advising on carbon-cost pass-through contractual issues, including change of law and pricing clauses and other connected drafting issues (such as dispute resolution) in supply and procurement agreements, sale and purchase agreements, leases, and financing and security agreements, and both as regards existing and new contracts
• Advising on, and implementing, due diligence scoping and planning in relation to asset and contract review in transactions, and
• Advising on climate change financing issues, from the points of view both of suppliers and takers of finance.

Emerging markets

Our legal service on emerging markets include:

• Assistance in realising new market opportunities, including in the areas of energy and renewable energy infrastructure, Kyoto Protocol CDM projects, creating and dealing in RECs, NGACs, VRETs and voluntary abatement, and the development, commercialisation and protection (IP) of carbon reduction technologies, and
• Advising on the establishment of carbon cost mitigation options and arrangements, including the establishment of carbon capture and storage developments, the securing of arrangements with Australian forestry suppliers and CDM opportunities.

Endnotes

1. Detailed summary of the Draft CPRS legislation.
2. The three types of international units under the Kyoto Protocol (namely: ‘certified emissions reductions’ (CERs) created under the Protocol’s Clean Development Mechanism (CDM); ‘emission reduction units’ created under the Protocol’s Joint Implementation Mechanism; and ‘removal units’ created by a country on the basis of land use change activities) will each be eligible international units. The CPRS Bill also makes provision for non-Kyoto units (units issued in accordance with international agreements other than the Kyoto Protocol) to be prescribed to be eligible international units.
3. These CDM costs appeared in Carbon Positive, Carbon News Feed on Monday 23 February 2009.Discussion regarding EU permit prices falling appeared in the Australian Financial Review on Thursday 29 January 2008, p13.

More information

For information regarding possible implications for your business, contact