Draft CPRS legislation – implications for the forestry industry

1 Climate change policy – current issues in the forestry industry

In December 2008, the Federal Government released its White Paper on the proposed Australian greenhouse gas emissions trading scheme, named the Carbon Pollution Reduction Scheme (CPRS) (White Paper).¹ On 10 March 2009, the Federal Government released an exposure draft of the Carbon Pollution Reduction Scheme Bill 2009 (Draft CPRS Bill) as well as detailed commentary to the Draft CPRS Bill (Commentary).

The proposed CPRS² is a cap-and-trade system, under which entities emitting greenhouse gases must acquire and surrender permits known as ‘Australian emissions units’³ (AEUs) to cover their emissions. The scheme is to be administered by a new body known as the Australian Climate Change Regulatory Authority (Authority).

Incentivising reforestation

The government will incentivise reforestation by issuing free AEUs according to the procedure discussed in this Fact Sheet.

Avoided deforestation is not covered

AEUs will not be issued for avoided deforestation, as discussed in the White Paper.⁴ Including deforestation in the CPRS was considered impractical, and existing measures to reduce deforestation are viewed as sufficient, although the government will continue to investigate incentive-based mechanisms such as offsets.⁵

1.1 Growth projections for the forestry industry under the CPRS

The CPRS covers several key industries, including the forestry sector and reforestation projects. Treasury, in its 2008 report Australia's Low Pollution Future: The Economics of Climate Change Mitigation (Economic Modelling), recognises the potential of forestry to offset substantial domestic emissions and ‘greatly reduce the costs of climate change mitigation in Australia.’⁶

The Economic Modelling predicts there will be increased investment in sequestration forests, established in order to generate AEUs for sale. The predicted area of new plantation forests, including sequestration forests, vary according to the emission reduction target for 2020 compared with 2000. (The proposed emissions target is an unconditional five per cent reduction by 2020, which will be increased to 15 per cent in the context of global agreement₇). The predicted additional area of these new forests in 2050 ranges between five million hectares for the five per cen reduction and 25 million hectares for the 15 per cent reduction.⁸ The 25 per cent reduction proposed by Professor Garnaut would result in 20 million additional hectares.

1.2 Industry concerns about the CPRS

Whilst the proposed CPRS should drive a structural shift in the economy benefitting low and negative-emission sectors such as forestry⁹,  there are several CPRS-related concerns for the forestry industry.

Firstly, lack of finalisation on forestry rules may discourage forestry investment in the short term. International rules relating to forestry are likely to be modified at the 15th Conference of the Parties of the United Nations Framework Convention on Climate Change in Copenhagen later this year. The National Association of Forest Industries (NAFI) suggests uncertainty surrounding these rules, such as the treatments of finished wood products as an emission, means ‘it is hard to see many forestry companies wanting to opt-in’.¹⁰

Secondly, the CPRS currently proposes that forestry will not be eligible for CPRS fuel credit payments. These payments are proposed for the agricultural and fishing industries as compensation for increased fuel costs under the CPRS that these industries will not receive under the cent for cent reduction in fuel excise (which they do not effectively pay).¹¹  According to NAFI, it is surprising that the forestry industry, especially given its economic importance, is specifically excluded.¹²

2 Reforestation under the CPRS

Reforestation will be included in the CPRS from commencement (currently expected to be June 2010) on a voluntary basis. The owners of ‘eligible reforestation projects’ may choose to become ‘recognised reforestation entities’ and may be issued free AEUs. These can be then sold in the same way as any other AEUs.

Once a person has an account with the National Registry of Emissions Units (a general requirement to receive AEUs), there are four steps to receiving free AEUs for a reforestation project (these are discussed in more detail in the following pages):

1. register to participate as a ‘recognised reforestation entity’
2. have the project declared as an ‘eligible reforestation project’
3. submit an initial ‘reforestation report’, and
4. apply for a ‘reforestation certificate’ with respect to the period covered by the report.

There are ongoing obligations, and the project may be made subject to a ‘forest maintenance obligation’ (for more detail on forest maintenance obligations, see 2.7 below).

However, only the holder of the carbon sequestration right (CSR) may receive free AEUs in relation to a reforestation project.¹³ CSRs are therefore central to this scheme. ‘Forestry rights’ are also important because a forest maintenance obligation, if imposed, is imposed on the person holding this right.

2.1 Carbon sequestration rights and forestry rights

Holding a CSR is a prerequisite to participation in this scheme.¹⁴ The Act will not create CSRs, but particular rights will be recognised as CSRs if they fall within the requirements specified in the Act.¹⁵ According to the Commentary, these requirements essentially require that the right is ‘the exclusive legal right to obtain the benefit of sequestration of carbon dioxide by trees to which an eligible reforestation project relates’.¹⁶

An interrelated concept is the ‘forestry right’. This is essentially any legal interest that gives the right to establish, maintain and manage a forest.¹⁷ As with CSRs, the Act will not create these interests.
The requirements for a right to be recognised as a CSR or a forestry right are stated in the Draft CPRS Bill,¹⁸ but the government has noted that these requirements are ‘still being developed’.¹⁹ The government has also flagged that the treatment of land subject to native title rights is still being considered.²⁰

CSRs and forestry rights in state legislation

A number of Australian states have introduced legislation which regulates and recognises the existence of forestry rights and CSRs in forests. The legislation allows persons who wish to invest in carbon rights and/or forestry rights to do so without having to own the land in which these rights exist or, in the case of carbon rights, without managing the trees in which carbon rights exist. These rights create greater flexibility in the ability to manage forest products, carbon credits and land over time, and enable the harmonisation of various classes of investors through the creation of investment products.

All of the states have, in one way or another, recognised registration of forestry rights and CSRs.²¹ Registering a forestry right or carbon sequestration right on land title generally means that it runs with the land and can prevent future landowners from removing or destroying the forest, providing protection of the vegetation if the land is sold. Registering a CSR binds future landowners.

There is no legislation dealing with CSRs or forestry rights in either the Australian Capital Territory or the Northern Territory, or at a Commonwealth level. Uncertainty exists as to whether CSRs can exist without specific legislation due to their unique nature. Further, characterising a CSR as a profit à prendre (the right to take something from another’s land), in the absence of legislation, may be problematic, as sequestration does not involve the taking of something from the land (crops, for example, or timber); sequestering carbon involves putting something—carbon—into the land over a period of time. Where no legislation exists, it may be possible that two parties can contract to create a right to sequester carbon. This right, however, cannot be registered on title and some risk attaches as a result.

The Draft CPRS Bill provides that the owner of land or a lessee with exclusive possession will generally have the CSR over that land, unless they have granted an interest in the land to another person.²²

CSRs and forestry rights may be held by separate persons

The scheme recognises that forestry rights and CSRs may be held by different persons over the same project. If this occurs, there are additional requirements.²³ First, if the land is Torrens system land, the CSR must be registered on the certificate of title. Second, the CSR must ‘run with the land’, ie. successors in title will take subject to that interest.

2.2 Registering as a reforestation entity

Application

Any person may apply to the Authority to become a ‘recognised reforestation entity’.²⁴ The regulations (not yet released) will specify what information or documents must accompany the application, and may specify an application fee. A decision should be made within 90 days.

Fit and proper person test

The Authority must be satisfied that the applicant is a ‘fit and proper person’ having regard to such things as whether the applicant has been convicted of an offence or has breached the Act.²⁵ The Authority must also be satisfied that the applicant is not insolvent or under administration. The regulations may specify additional criteria.

Once granted, recognition may be cancelled by the Authority if the Authority is satisfied the person no longer satisfies the criteria for recognition.²⁶ The recognition may be surrendered, but is not transferable.

2.3 Eligible reforestation projects

A person may apply to the Authority to have a reforestation project declared to be an ‘eligible reforestation project’.²⁷ The regulations will specify what information or documents must accompany the application, and may specify an application fee. The Authority may require the applicant to provide further information, and if the applicant fails to provide this information, the Authority may refuse to consider the application or refuse to take any action. A decision should be made within 90 days.

The applicant may withdraw the application at any time and the fee will be returned. This is intended to allow applicants to amend the project so that it is scheme compliant, and they may reapply in relation to that project.

Kyoto compliance

To be eligible, the reforestation project must relate to the management and maintenance of a ‘forest stand’, as defined in the Act.²⁸ Essentially this means that the project must be Kyoto Protocol compliant. This means that:

1. the forest is:
   • comprised of trees with a potential height of at least two metres and crown cover of at least 20 per cent, and
   • in patches greater than 0.2 hectares in area
2. a positive human action has been undertaken to establish the forest (eg. suspension of grazing to encourage growth²⁹), and
3. the forest was planted after 1 January 1990.

The reforestation project must also meet any other requirements specified in the regulations. These requirements are expected to go to the calculation and reporting of net greenhouse gas reduction such as requiring that the trees comprising the project are:

1. established at the same time within a single encompassing boundary
2. of the same species, and
3. subject to the same management regime.³⁰

Other criteria

The Authority must be satisfied that:

1. the applicant holds the CSR (see 2.1 above)
2. the applicant is a recognised reforestation entity (see 2.2 above)
3. the project is on freehold Torrens system land (held under a single title³¹) or Crown land, and
4. the applicant meets the eligibility requirements (if any) specified in the regulations.

If the project is on Crown land, the applicant may also require a certificate from the Crown certifying that the applicant holds the CSR and the Crown will not deal with the land, or consent to anyone dealing with the land, in a manner inconsistent with that CSR.³²

Consent

In addition to the above, the Authority must be satisfied that the holders of certain interests in the land have consented.³³ This is because the land may become subject to a ‘forest maintenance obligation’ (see 2.7 below). This requirement gives the relevant interest holders the opportunity to negotiate.³⁴

The interest holders who must consent are:

• the registered owner of the land
• the holder of the ‘forestry right’ in relation to the project (discussed at 2.1 above), and
• any registered mortgagee of the project area.

Two future amendments

The government has flagged two aspects of these criteria which are still under consideration.³⁵

First, the requirement that a project on Torrens land must be on a single title is expected to be removed.

Second, the criteria that should apply for land subject to native title rights are yet to be included in the Draft CPRS Bill.

2.4 Issue of AEUs

Calculation and adjustment of AEU limits

Once a project has been declared to be an eligible reforestation project, the Authority will issue to the applicant for the declaration a notice specifying the ‘reforestation unit limit’ for the project.³⁶ This is the maximum total number of AEUs that will be issued over time for that project. This limit is based on the project’s projected net greenhouse gas removals. AEUs will be issued to reflect average greenhouse gas removals, as opposed to actual removals in any given year, over the long term of the project (eg. 70 years).

AEU limits are calculated for each forest on the basis of emissions estimates, which will be generated using a computer program incorporating a prescribed method, which is currently expected to be an updated version of the National Carbon Accounting Toolbox using input data such as tree species, year of establishment, thinning events, rotation length and fertiliser application.³⁷ Each AEU limit will be reviewed periodically (to reflect changes in the forest, the prescribed method or international rules) and, if adjusted, the forest entity may be issued further AEUs or required to surrender AEUs accordingly (surrendering is discussed at 2.5 below). Five years advance notice will generally be given to the forest entity if there are significant changes to the prescribed method or the international rules.³⁸

AEU limits will also incorporate a margin, or ‘risk of reversal buffer’, to allow for natural disturbances which may lower the actual net greenhouse gas removals such as fire, insect attack, storms or severe drought.³⁹ Because the risk is already built in to the AEU limit, forest entities will not generally be required to surrender AEUs when natural disturbances actually do occur.

Reforestation report

Recognised reforestation entities must submit a ‘reforestation report’ to the Authority within the first five years, but not within the first 12 months, of the project being declared eligible.⁴⁰ A reforestation report must contain the information required by the regulations.⁴¹ This is expected to be the data required by the National Carbon Accounting Toolbox, such as establishment date, species and harvesting and thinning schedules.⁴²

The entity must submit a reforestation report for each reporting period. Entities nominate their own reporting period, which must be between one and five years.

Reforestation certificate

Once a reforestation report has been issued, the reforestation entity may apply to the Authority for a ‘reforestation certificate’ in respect of the nominated reporting period.⁴³ There may be an application fee, and the certificate is not transferable. The Authority may require the applicant to provide further information, and if the applicant fails to provide this information, the Authority may refuse to consider the application or refuse to take any action. A decision should be made within 90 days.

The Authority must issue a reforestation certificate if the following criteria are satisfied:

1. the applicant is a recognised reforestation entity and has the CSR in relation to the reforestation project
2. the applicant is not subject to a requirement to relinquish AEUs issued in relation to the project or an outstanding requirement to pay an administrative penalty
3. the project has resulted in a net increase in greenhouse gas removals of at least one tonne
4. the net total number of tonnes of greenhouse gas emissions removed by the project are greater than the net total number of AEUs issued in respect of the project
5. the AEU limit for the project has not yet been reached, and
6. any other requirements specified in the regulations are satisfied.

Issue of AEUs

A reforestation certificate entitles the holder to the number of free AEUs stated on the certificate.⁴⁴ This number will be calculated by computer using information provided by the applicant for the certificate.⁴⁵ As with the calculation of AEU limits, the government expects to be using an updated version of the National Carbon Accounting Toolbox.⁴⁶

The unit entitlement for a reforestation project will be the lesser of:⁴⁷

• the net total number of tonnes of greenhouse gas emissions removed by the forest minus the total number of AEUs issued for the project, or
• the AEU limit for the project minus the total number of AEUs issued for the project.

AEUs will be issued for net greenhouse gas removals, and not in advance.⁴⁸

Note that in order to receive AEUs, you must have an account with the National Registry of Emissions Units. AEUs will not be issued to the holder of a reforestation certificate unless the certificate holder has a Registry account.

2.5 Surrendering AEUs

In some circumstances, reforestation AEUs may need to be relinquished.⁴⁹ Reforestation entities will have to surrender AEUs in two circumstances:

1. Revocation

In certain circumstances, the Authority may unilaterally revoke the declaration of the project as an eligible reforestation project.  If this occurs, the reforestation entity must relinquish the net total number of AEUs issued in relation to that project.⁵⁰

There are three circumstances where the Authority may unilaterally revoke the declaration of a project as an eligible reforestation project:

1. forest cleared: the whole of the project area remains clear of a Kyoto compliant forest for a continuous period of five years⁵¹
2. eligibility criteria not met: the Authority is satisfied that the project no longer satisfies one or more reforestation scheme criteria⁵², and
3. transfer of CSR: the CSR holder in relation to the project ceases to hold that right, and there was no ‘relinquishment obligation transfer agreement’ in force within 90 days.⁵³

A ‘relinquishment obligation transfer agreement’ is an agreement between a CSR holder in relation to an eligible reforestation project and a person to whom that right is being transferred.⁵⁴ The Act will set out the conditions that must be satisfied for an agreement to constitute a ‘relinquishment obligation transfer agreement’:

1. the transferee must be an eligible reforestation entity
2. the agreement must state that the transferee accepts responsibility for complying with any future requirements to relinquish AEUs, and (if required by the Authority) has provided any security for performance of this obligation, and
3. the Authority must approve the agreement in writing.

2. AEU unit limit decreases

If the AEU unit limit for the project decreases and the number of AEUs already issued exceeds this decreased number, the reforestation entity must relinquish the excess.⁵⁵

Failure to comply with a notice of relinquishment

If a reforestation entity does not comply with a relinquishment requirement with 90 days of receiving notice from the Authority, the reforestation project will become subject to a ‘forest maintenance obligation. This is discussed at 2.7 below. In addition, a financial penalty must be paid within 30 days of the non-compliance.⁵⁶ This penalty is a prescribed amount per AEU not yet relinquished. The prescribed amount is 200 per cent of the benchmark average auction price for the previous financial year, or such other amount specified in the regulations.

The penalty is payable within 30 days of the compliance deadline, and from this date interest accrues as a late payment penalty.⁵⁷ This interest rate is 20 per cent per annum, or such other rate specified in the regulations. The Authority may remit this late payment penalty.⁵⁸

The Authority may take court action to recover the penalty, including any interest.⁵⁹

2.6 Ongoing obligations

Reporting

The forestry industry will be expected to report under the CPRS less frequently than other sectors because reforestation entities will generally receive AEUs for carbon sequestration, rather than surrender AEUs for emissions.⁶⁰ Reforestation entities must submit an initial reforestation report, discussed above, and subsequent reports at least every five years.⁶¹

Although not yet stated in the Draft CPRS Bill, the legislation will require the reforestation entity to notify the Authority of any events or data likely to cause a material change to these estimates, such as management actions like unplanned harvesting or significant natural disturbances.⁶²

Taxation liability

Expenses incurred in relation to establishing and maintaining a Kyoto compliant forest are already deductable under tax law. Proceeds from the sale of AEUs will be assessable for income tax purposes.⁶³ If AEUs are retained at the end of the tax year in which they are issued, their value will be included in the entity’s rolling balance as follows:

• if historical cost is the valuation method, the market value at the date of issue, or
• if market value is the valuation method, the market value at the end of the year.⁶⁴

A deduction can then be made in the year of the AEU’s sale, use or surrender.

2.7 Forest maintenance obligations

A reforestation project may, in limited circumstances, become subject to a ‘forest maintenance obligation’.⁶⁵ This only applies where the reforestation entity has been served with a notice requiring the relinquishment of AEUs (see 2.5 above) and the entity has not complied with that notice within 90 days.⁶⁶

The obligation applies at all times after that 90 day period until:

1. the penalty and any interest discussed at 2.5 above is paid in full, or
2. the forestry right holder relinquishes the net total number of AEUs issued in respect of the project.⁶⁷

(It should be noted that paragraph (b) is mentioned in the Commentary,⁶⁸ but is not actually stated in the Draft CPRS Bill. This appears to be an oversight.)

The holder of the forestry right must comply

The person who must comply with the obligation is the person who, at any point in time while the obligation operates, is the holder of the forestry right in relation to the project. Forestry rights are discussed at 2.1 above.

The obligation: establish & maintain the forest

The holder of the forestry right must establish and maintain forest stands on the project area such that it is reasonable to expect that, at maturity, the reforestation project will remove greenhouse gases equivalent to the number of AEUs issued for the project.⁶⁹ The Authority may direct how this obligation is to be carried out,⁷⁰ and may apply to the Federal Court to enforce compliance by injunction.⁷¹

3 Submissions and lobbying

The Federal Government will accept submissions on the Draft CPRS Bill before 14 April 2009. This means that there is very limited time for stakeholders to digest the ramifications of the Draft CPRS Bill and to lobby for changes.

Although the Draft CPRS Bill largely reflects the White Paper, recent political discussions surrounding the CPRS indicate that the Federal Government will need to negotiate and possibly concede on significant aspects of the bill in order for it to pass the Senate.

4 How Freehills can help

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. Visit our website for details on how Freehills can help.

Endnotes

1. Australian Government, Carbon Pollution Reduction Scheme: Australia’s Low Pollution Future, Commonwealth of Australia, December 2008.
2. Further detail on the proposals made in the Draft CPRS Bill
3. Draft CPRS Bill cl 83.
4. White Paper, Section 6.14.
5. White Paper, 6-61.
6. Economic Modelling, 185.
7. White Paper, Section 4.2.
8. Economic Modelling, 185–186.
9. Economic Modelling, 162.
10. See NAFI website.
11. White Paper, 17-17.
12. See NAFI website.
13. Draft CPRS Bill, cl 195(2)(b); Commentary, 171.
14. Commentary, 171.
15. ‘Carbon sequestration right’ is defined in cl 240 of the Draft CPRS Bill.
16. Commentary, 172.
17. ‘Forestry right’ is defined in cl 241 of the Draft CPRS Bill, and discussed at pp 171 – 171 of the Commentary.
18. Clauses 240 and 241.
19. Commentary, 173 – 174.
20. Ibid.
21. Conveyancing Act 1919 (NSW), Forestry Act 1916 (NSW) and Crown Lands Legislation Amendment (Carbon Sequestration) Act 2006 (NSW), Carbon Rights Act 2003 (WA), Forestry Rights Act 1996 (Vic), Forest Property Act 2000 (SA), Forestry Act 1959 (Qld), Forestry Rights Registration Act 1990 (Tas).
22. Draft CPRS Bill, cl cl 240; Commentary, 172.
23. Commentary, 173.
24. Draft CPRS Bill, Pt 10 Div 4.
25. Draft CPRS Bill cl 201.
26. Draft CPRS Bill, cl 202.
27. Draft CPRS Bill, Pt 10 Div 5.
28. Draft CPRS Bill, cl 5.
29. White Paper, 6-47.
30. Commentary, 168.
31. The government expects to remove this requirement.
32. Draft CPRS Bill, cl 209(4(f).
33. Draft CPRS Bill, cl 209(4)(e).
34. Commentary, 169.
35. Commentary, 169 – 171.
36. Draft CPRS Bill, cl 220.
37. White Paper, 6-52 to 6-53; Commentary, 175.
38. White Paper, 6-57.
39. White Paper, 6-56.
40. Draft CPRS Bill, cl 223.
41. Draft CPRS Bill, cl 225(3)(b).
42. Commentary, 175.
43. Draft CPRS Bill, Pt 10 Div 3.
44. Draft CPRS Bill, cl 191.
45. Draft CPRS Bill, cl 195.
46. Commentary, 179.
47. Draft CPRS Bill, cl 196.
48. Commentary, 179.
49. Draft CPRS Bill, Pt 10 Div 10.
50. Draft CPRS Bill, cl 232.
51. Draft CPRS Bill, cl 217.
52. Draft CPRS Bill, cl 218.
53. Draft CPRS Bill, cl 219.
54. Draft CPRS Bill, cl 234.
55. Draft CPRS Bill, cl 233.
56. Draft CPRS Bill, cl 287; Commentary 227.
57. Draft CPRS Bill, cl 288(1).
58. Draft CPRS Bill, cl 288(2).
59. Draft CPRS Bill, cl 289.
60. White Paper, 6-53.
61. Draft CPRS Bill, cl 224.
62. White Paper, 6-53 to 6-54; Commentary, 175.
63. White Paper, 14-17.
64. White Paper, 14-18.
65. Draft CPRS Bill, Pt 10 Div 9.
66. Draft CPRS Bill, cl 226(1).
67. A sunset provision also applies – this is 130 years after the first AEU is issued in relation to the project: Draft CPRS Bill, cl 226(7)(b).
68. Commentary, 187 – 188.
69. Draft CPRS Bill, cl 226(2).
70. Draft CPRS Bill, cl 226(3).
71. Draft CPRS Bill, cl 227 (injunction) and 228 (interim injunction).

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