CPRS White Paper – issues for banking and project finance

Overview of proposed CPRS

• On 10 March 2009, the Australian Federal Government released exposure draft legislation for its proposed greenhouse gas emissions trading scheme, the Carbon Pollution Reduction Scheme (CPRS), in the form of the Carbon Pollution Reduction Scheme Bill 2009 (Cth) and associated Bills (Draft CPRS legislation).
• The Draft CPRS legislation closely follows the policy positions set out in the White Paper, released on 15 December 2008.
• The government’s long-term target is for a 60 per cent reduction against 2000 emission levels by 2050, with the medium-term target being a 5-15 per cent reduction against 2000 levels by 2020.
• The consultation period for the Draft CPRS legislation closes on 14 April 2009. The CPRS is scheduled to commence on 1 July 2010.

Features of the CPRS

• Cap-and-trade system: the government will set a cap on the total emissions of covered greenhouse gases in covered sectors for each financial year, and will issue permits, to be known as Australian Emissions Units (AEUs). A company that emits covered greenhouse gases is then obliged to surrender AEU’s or eligible international units (EIUs) for those emissions.
• AEUs will be: 
  • allocated for free (to certain emitters)
  • auctioned by the government monthly. Auction participants may be required to give guarantees in respect of payment obligations
  • issued for a fixed charge (for the first five years of operation of the CPRS). Fixed charge AEUs will initially be available at A$40 per tonne of carbon dioxide equivalent, with the cost increasing by approximately five per cent in real terms per year, and
  • issued for free to forestry providers that opt into the CPRS, for those forests’ net removal of carbon dioxide from the atmosphere.
• The Draft CPRS legislation confirms that there will be no quantitative restrictions on the use of EIUs¹ for compliance in the CPRS. The market for EIUs, particularly Certified Emissions Reductions (CERs) under the Clean Development Mechanism (CDM) program, is developed and large compared to Australia’s total emissions and will operate as a further ceiling on the price of AEUs and compliance under the CPRS. If the price for purchasing AEUs rose above the price of EIUs then emitters could simply purchase EIUs 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.²
• Covered sectors will initially include stationary energy, transport, industrial processes, waste, emissions of synthetic greenhouse gases and fugitive emissions during the production, processing, transport, storage and distribution of coal, oil and gas. Detailed treatment of these covered sectors is not contained in the Draft CPRS legislation and will need to be covered in the subsequent CPRS and reporting regulations.
• Agriculture will not be a covered sector initially, but may be brought into the CPRS from 2015. A final decision on the inclusion of agriculture is planned to be made in 2013.
• Owners of Kyoto-compliant forests (in short, forests established from 1990 onwards on previously cleared land) who opt into the CPRS will be able to receive free AEUs for those forests’ net removal of carbon dioxide from the atmosphere.
• Any greenhouse gases which have been captured and stored from the emissions of the originating source (for example from liquefied natural gas production or power stations) will be effectively subtracted from the calculation of emissions from that source.
• Companies can trade AEUs (by assignment or by operation of law), bank AEUs for use in future years and borrow AEUs from the government from a future year for use in the current year. Fixed charge AEUs however, are incapable of being banked or traded. Borrowing of AEUs from the government will only be available to a limited extent (a company will be able to meet up to five per cent of its liabilities in any financial year by borrowing from the following year’s AEUs from the government). 
• AEUs will be created as personal property and, other than in the case of misrepresentation or fraud, there will be no power to extinguish AEUs without compensation. 
• The CPRS doesn’t prevent the creation of equitable interests in AEUs or the taking of security over them. However, ‘further consideration will be given … to the mechanisms for taking security over them’.³
• AEUs will be designated ‘financial products’ for the purposes of the provisions in the Corporations Act 2001 (Cth) regulating those products and their marketing.
• No domestic ‘offsets’ (a recognition for emission reductions, which could be purchased and then used to satisfy CPRS liabilities by other emitters) will be recognised under the CPRS initially. In 2013 the government will give further consideration to the scope for offsets generated in sectors that cannot be included in the CPRS.
• The point of liability for surrendering AEUs will, in general, be the point where the emissions actually occur. In some circumstances an upstream supply point will be used for convenience, for example for ‘eligible upstream fuels’ (with liability being mandatorily transferred down the supply chain through the use of an ‘Obligation Transfer Number’ in set circumstances and voluntarily transferred in other circumstances). In general, entities with ‘operational control’ over ‘covered facilities’ will be liable under the CPRS where emissions exceed the set threshold, which is generally set at 25,000 tonnes of carbon dioxide equivalent.
• Penalties will apply where companies emit greenhouse gases without surrendering sufficient AEUs or EIUs. The penalty will be an additional 10 per cent on the average cost of AEUs in the relevant period with an additional 20 per cent penalty if the penalty is not paid on time. There will also be a ‘make-good’ obligation requiring the shortfall to be made up in the following year.

Impacts on banking and project finance

The introduction of the CPRS may affect banking and project financing in the following ways:

• As part of due diligence, financiers will seek to assess the CPRS liability of borrowers and projects and the associated compliance costs. Those costs may affect project feasibility, asset values and future cash flows, which in turn may affect the propensity of financiers to lend and the prevailing lending rates.
• The introduction of the CPRS may also have cash flow implications for existing financing transactions. In those cases, the existing documentation should be reviewed and may need to be amended.
• Financiers may look to take security over AEUs or EIUs (collectively referred to as ‘permits’) held by borrowers which are required for the relevant project. It is likely that financiers will engage in forecasting to determine the number of permits required over the lifetime of the project and ensure that, in the case of default or insolvency, a sufficient number of permits AEUs can be sold to a third party buyer along with the rest of the project. As noted in section 2 above, further guidance is expected in relation to the mechanisms for taking security over permits.
• While borrowers may look to reduce emissions to lower their CPRS compliance costs, financiers may require borrowers to bank (rather than sell) surplus permits in a given year to offset any fluctuations in emission levels in future years in which permit prices may be significantly higher.
• As noted in section 2 above, a company’s ability to borrow AEUs from the government from future years is limited. Accordingly, where a borrower needs additional permits, it is likely that a financier would prefer the borrower to enter into contractual arrangements with non-government entities, rather than borrowing AEUs from the government. However, financiers may restrict a borrower’s ability to borrow permits unless the relevant contractual arrangement to obtain the permits fixes the price (or price range) payable for the permits.
• As it is anticipated that secondary markets will develop in which the AEUs are traded, financiers may also require borrowers to utilise derivative and swap instruments to mitigate the risk of not complying with the CPRS (e.g. to ensure borrowers have sufficient AEUs over the lifetime of a project). Such instruments are already available for EIUs.
• Obtaining sufficient permits for relevant years may be an undertaking required of a borrower under a facility agreement which, if breached, may constitute a review event or an event of default. 
• Where a borrower needs to purchase permits and enters into contractual arrangements to obtain those permits, a financier may wish to enter into a tripartite agreement with the borrower and the permit-provider to ensure that, in the case of default, the financier can step in and receive the benefit of the permits required in respect of the project. 
• Under many financing structures, financiers could be liable to surrender permits because they are deemed to have taken operational control of the facilities which are the subject of those structures. For example when exercising enforcement provisions in a relevant financing document, or if under the financing arrangements the financier has dictated the operational, occupational health and safety or environmental policies. Accordingly, these matters need to be carefully considered.

Next steps

• The Federal Government is aiming is to pass the CPRS legislation by June 2009. 
• As the government does not control the Senate, it will need the support there of either the Opposition Liberal and National Parties or all of the Greens and the two independents from Victoria (Fielding) and South Australia (Xenophon). 
• The initial reaction of the Green Party has been negative to the medium term target and the industry compensation mechanisms. 
• 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.
• Accordingly, further changes to the CPRS design and possibly an entirely alternative approach are possible.

Endnotes

1. 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 EIUs recognised in the CPRS. 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 EIUs recognised in the CPRS.
2. 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.
3. Commentary to the Carbon Pollution Reduction Scheme Bill 2009 (Cth), p92.

More information

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